Question

A company will pay a $2 per share dividend in 1 year. The dividend in 2 years will be $4 per share, and it is expected that dividends will grow at 2% per year thereafter. The expected rate of return on the stock is 16%. a. What is the current price of the stock?

Answer 1

Answer:

$26.35

Explanation:

Use dividend discount model (DDM) to solve this question.

First, find the present value of each year's dividend;

PV (of D1 ) = 2/ (1.16) = 1.7241

PV (of D2 ) = 4/ (1.16²) = 2.9727

Yr 3 dividend (D3) = D2(1+g) = 4(1+0.02) = 4.08

PV (of D3 ) = $\frac{\frac{4.08}{0.16-0.02} }{1.16^{2} }$

PV (of D3) = 29.1429/1.3456 =21.6579

Next, to find price, sum up the present values;

1.7241 + 2.9727 + 21.6579 = 26.35

Therefore, the current price of the stock is $26.35