Math Problem Statement
Procter and Gamble (PG) paid an annual dividend of $3.40 in 20212021. You expect PG to increase its dividends by 8.0% per year for the next five years (through 2026), and thereafter by 3.0% per year. If the appropriate equity cost of capital for Procter and Gamble is 6.0% per year, use the dividend-discount model to estimate its value per share at the end of 2021.
Solution
To estimate the value of Procter & Gamble (PG) shares at the end of 2021 using the dividend-discount model (DDM), we follow these steps:
Step 1: Calculate the dividends for the first 5 years (2022-2026)
Given that the dividend increases by 8% per year for the first 5 years, we calculate the dividends as follows:
- (2022) =
- (2023) =
- (2024) =
- (2025) =
- (2026) =
Step 2: Calculate the terminal value
Starting from 2027, the dividends grow at 3% indefinitely. The terminal value at the end of 2026 is based on the dividend in 2027 (which is ) and the growth rate of 3%. We use the formula for the terminal value:
Where:
- is the dividend in 2027,
- is the cost of equity,
- is the long-term growth rate.
First, calculate :
Now calculate the terminal value:
Step 3: Calculate the present value of the dividends and the terminal value
We now discount the dividends and the terminal value back to the end of 2021 using the formula for the present value:
We calculate the present value for each dividend and the terminal value:
Now, discount the terminal value:
Step 4: Sum the present values
Finally, we sum up the present values of the dividends and the terminal value:
Conclusion:
The estimated value of Procter & Gamble’s stock at the end of 2021 is approximately $146.15 per share.
Would you like more details on any step or have any questions?
Here are some related questions:
- How does the dividend growth rate impact the valuation of a stock?
- What happens to stock value if the cost of equity increases?
- How is the terminal value calculated in different valuation models?
- Why is it important to discount future dividends?
- Can dividend-discount models be applied to non-dividend-paying companies?
Tip: Always compare different growth scenarios (optimistic, realistic, pessimistic) when estimating stock prices using models like DDM.
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Math Problem Analysis
Mathematical Concepts
Finance
Stock Valuation
Dividend-Discount Model
Present Value
Formulas
Future Dividend Calculation: D_t = D_0 × (1 + g)^t
Terminal Value Calculation: TV = D_t / (r - g)
Present Value Calculation: PV = D_t / (1 + r)^t
Theorems
Dividend-Discount Model (DDM)
Suitable Grade Level
Undergraduate Finance or Business Students
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