Use the constant growth model to calculate

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Week#4

You are analyzing Jillian's Jewelry (JJ) stock for a possible purchase. JJ just paid a dividend of \$2.25 yesterday. You expect the dividend to grow at the rate of 5% per year for the next 3 years, if you buy the stock; you plan to hold it for 3 years and then sell it.

a. What dividends do you expect for JJ stock over the next 3 years? In other words, calculate D1, D2 and D3. Note that D0 = \$2.25.

b. JJ's stock has a required return of 13%, and so this is the rate you'll use to discount dividends. Find the present value of the dividend stream; that is, calculate the PV of D1, D2, and D3, and then sum these PVs.

c. JJ stock should trade for \$34.19 3 years from now (i.e., you expect = \$34.19). Discounted at a 13% rate, what is the present value of this expected future stock price? In other words, calculate the PV of \$34.19.

d. If you plan to buy the stock, hold it for 3 years, and then sell it for \$34.19, what is the most you should pay for it?

e. Use the constant growth model to calculate the present value of this stock. Assume that g = 5%, and it is constant.

f. Is the value of this stock dependent on how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today? Explain your answer.

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