Question

Savickas Petroleum’s stock has a required return of 12%, and the stock sells for $43 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock’s expected constant growth rate after t = 4, i.e., what is X?

a.
5.15%

b.
6.78%

c.
6.37%

d.
5.49%

e.
7.25%

Answer 1

Answer:

correct option is b.  6.78%

Explanation:

given data

required return = 12%

stock sells = $43 per share

dividend = $1.00

expected to grow = 30%

D4 = $1.00 × $(1.30)^4$ = $2.8561

solution

we get here first present value of dividend for 4 year that is

year        cash flow                   pv(13%)           present value

1                $1.30                        0.8929             $1.16                

2                $1.69                       0.7972              $1.35        

3                $2.20                      0.7118                $1.56  

4                $2.86                      0.6355               $1.82  

so  

present value of dividend for 4 year is = $5.8868

so

price of stock will be

price of stock = present value of dividend + price at year 4

43 = 5.8868 + $\frac{2.86 \times (1+x)}{0.12-x}$  

solve it we get

x = 6.78%

so correct option is b.  6.78%