A company is considering the following two dividend policies for the next five years. Year Policy #1 Policy #2 1 $4.00 $6.00 2 $4.00 $2.70 3 $4.00 $5.00 4 $4.00 $3.10 5 $4.00 $3.20 Required: Part 1: How much total dividends per share will the stockholders receive over the five year period under each policy? Part 2: If investors see no difference in risk between the two policies, and therefore apply a 9.4% discount rate to both, what is the present value of each dividend stream? Part 3: Suppose investors see Policy #2 as the riskier of the two. And they therefore apply a 9.4% discount rate to Policy #1 but a 14% discount rate to Policy #2. Under this scenario, what is the present value of each dividend stream? Part 4: What conclusions can be drawn from this exercise?
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
A company is considering the following two dividend policies for the next five years.
| Year | Policy #1 | Policy #2 |
| 1 | $4.00 | $6.00 |
| 2 | $4.00 | $2.70 |
| 3 | $4.00 | $5.00 |
| 4 | $4.00 | $3.10 |
| 5 | $4.00 | $3.20 |
Required:
Part 1: How much total dividends per share will the stockholders receive over the five year period under each policy?
Part 2: If investors see no difference in risk between the two policies, and therefore apply a 9.4% discount rate to both, what is the
Part 3: Suppose investors see Policy #2 as the riskier of the two. And they therefore apply a 9.4% discount rate to Policy #1 but a 14% discount rate to Policy #2. Under this scenario, what is the present value of each dividend stream?
Part 4: What conclusions can be drawn from this exercise?
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