The most recent (2003) annual dividend payment of Warren Industries, a rapidly growing boat…


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The most recent (2003) annual dividend payment of Warren Industries, a rapidly growing boat manufacturer, was $1.50 per share. The firm’s financial manager expects that these dividends will increase at a 10% annual rate, g1, over the next 3 years (2004, 2005, and 2006) because the introduction of a hot new boat. At the end of the 3 years (the end of 2006), the firm’s mature product line is expected to result in a slowing of the dividend growth rate to 5% per year, g2, for the foreseeable future. The firm’s required return, ks, is 15%. To estimate the current (end-of-2003) value of Warren’s common stock, P0= P2003, the four-step procedure must be applied to these data. Step 1 The value of the cash dividends in each of the next 3 years is calculated in columns 1, 2, and 3 of Table 7.3. The 2004, 2005, and 2006 dividends are $1.65, $1.82, and $2.00, respectively. Step 2 The present value of the three dividends expected during the 2004–2006 initial growth period is calculated in columns 3, 4, and 5 of Table 7.3. The sum of the present values of the three dividends is $4.14. Step 3 The value of the stock at the end of the initial growth period (N = 2006) can be found by first calculating DN-1 = D2007: D2007 = D2006 ×(1 + 0.05) = $2.00 × (1.05) = $2.10 By using D2007= $2.10, a 15% required return, and a 5% dividend growth rate, we can calculate the value of the stock at the end of 2006 as follows: Finally, in Step 3, the share value of $21 at the end of 2006 must be converted into a present (end-of-2003) value. Using the 15% required return, we get Step 4 Adding the present value of the initial dividend stream (found in Step 2) to the present value of the stock at the end of the initial growth period (found in Step 3) as specified in Equation 7.6, we get the current (end-of- 2003) value of Warren Industries stock: P2003 = $4.14 + $13.82 = $17.96 per share The stock is currently worth $17.96 per share. The calculation of this value is depicted graphically on the following time line.

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