Question

Upton Co. is growing quickly. Dividends are expected to grow at 24 percent for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 14 percent and the company just paid a dividend of $3.40, what is the current share price?

Answer 1

Answer:

The correct answer is $70.07

Explanation:

According to the scenario, the given data are as follows:

Expected growth rate = 24%

Constant growth rate = 6%

Required return = 14%

Dividend paid = $3.40

So, we can find the current share price by using following method:

First we find the dividends for 3 years so,

Dividends for 1st year (D1)= $3.40 x 1.24 = $ 4.216

Dividend for 2nd year (D2) = $4.216 x 1.24 = $ 5.22784

Dividend for 3rd year (D3) = $5.22784 x 1.24 = 6.4825216

So, Stock price after 3rd year (P3) = Dividend for 3rd year x (1 + constant growth rate) / ( required return – constant growth rate)

By putting the value we get,

= $6.4825216 x ( 1 + 0.06 ) / (0.14 – 0.06)

= $6.4825216 x 13.25

= $85.8934112

Now, Current share price = D1 /  ( 1 + r ) + D2 / ( 1 + r )^2 + D3 / ( 1+r )^3 + P3 / (1 + r )^3

So, by putting the following value, we get:

=  $4.216 / (1 + 0.14) + $5.22784 / (1 + 0.14)^2 + 6.4825216 / (1+ 0.14)^3 + $85.8934112 / (1+ 0.14)^3

= $3.698245614 + $4.022653124 + $4.375517433 + $57.97560599

= $70.07 (approx.)

Hence, the current share price is $70.07.