Question

In doing a five-year analysis of future dividends, the Dawson Corporation is considering the following two plans. The values represent dividends per share.

Year	Plan A	Plan B
1	\(1.70	\)0.60
2	\(1.70	\)2.50
3	\(1.70	\)0.30
4	\(1.90	\)5.00
5	\(1.90	\)1.30

a. How much in total dividends per share will be paid under each plan over the five years?

b. Mr. Bright, the vice president of finance, suggests that stockholders often prefer a stable dividend policy to a highly variable one. He will assume that stockholders apply a lower discount rate to dividends that are stable. The discount rate to be used for Plan A is 11 percent; the discount rate for Plan B is 14 percent. Compute the present value of future dividends. Which plan will provide the higher present value for the future dividends? (Round to two places to the right of the decimal point.)

Short answer

The dividend in plan A is $8.90, and the dividend in plan B is $9.70. The present value of future dividends is $6.52 in plan A and $6.28 in plan B. Plan A will provide a higher present value for future dividends.

Step-by-step solution

Calculation of total dividends paid in five years

The dividend paid in plan A is $8.90 and plan B is $9.70.

$\begin{array}{rcl}\text{Plan A}& =& \text{Dividend in year 1}+\text{Dividend in year 2}+\text{Dividend in year 3}\\ & & +\text{Dividend in year 4}+\text{Dividend in year 5}\\ & =& \$1.70+\$1.70+\$1.70+\$1.90+\$1.90\\ & =& \$8.90\end{array}$

$\begin{array}{rcl}\text{Plan B}& =& \text{Dividend in year 1}+\text{Dividend in year 2}+\text{Dividend in year 3}\\ & & +\text{Dividend in year 4}+\text{Dividend in year 5}\\ & =& \$0.60+\$2.50+\$0.30+\$5.00+\$1.30\\ & =& \$9.70\\ & & \end{array}$

Calculation of present value of future dividends

The present value of future dividends is $6.52 in plan A and $6.28 in plan B. Plan A will provide more present value for future dividends.

Year	Dividend per share	PVIF(11%)	PV
1	$1.70	0.9009	$1.53
2	$1.70	0.8116	$1.38
3	$1.70	0.7312	$1.24
4	$1.90	0.6587	$1.25
5	$1.90	0.5935	$1.12
PV of future dividends	$6.52

Year	Dividend per share	PVIF(14%)	PV
1	$0.60	0.8772	$0.53
2	$2.50	0.7695	$1.92
3	$0.30	0.6750	$0.20
4	$5.00	0.5921	$2.96
5	$1.30	0.5194	$0.67
PV of future dividends	$6.28