(Q17 IN TYPE B) TD BANK’S EARNINGS AND DIVIDENDS ARE EXPECTED TO G...

17. (Q17 in Type B) TD Bank’s earnings and dividends are expected to grow at a rate of 10% during the next 2 years, at 8% in the third year, and at a constant rate of 6% thereafter. If last dividend paid was $1 and the required rate of return on its common stock is 12%. How much should you pay today for one share of TD Bank? A) $19.31 B) $24.66 C) $25.97 D) $28.02 Solution: A g

1

, g

2

= 10% g

3

= 8% g

4

and onwards = 6% r = 12% DIV

0

= 1.00 Constant Growth DDM P

0

= DIV

1

and P

3

= DIV

4

= DIV

3

(1 +g) r – g r – g r - g First, Find DIV

3

DIV

1

= DIV

0

(1 +g) = 1.00 (1.10) = 1.10 DIV

2

= DIV

1

(1 +g) = 1.10 (1.10) = 1.21 DIV

3

= DIV

2

(1 +g) = 1.21 (1.08) = 1.3068 DIV

4

= DIV

3

(1 +g) = 1.3068 (1.06) = 1.3852 P

3

= 1.3852 / (.12-.06) =$23.09 P

0

= DIV

1

/(1 +r)

¹

+ DIV

2

/(1 +r)

²

+ DIV

3

/(1 +r)

³

+ P

3

/(1 +r )

³

= 1.10/(1.12) + 1.21/(1.12)

²

+ 1.3068/(1.12)

³

+ 23.09/(1.12)

³

= 0.9821 + 0.9646 + .9302 + 16.4350 = $19.31