Question

A stock just paid a dividend of $1.00 per share. Analysts expect dividends to grow at a rate of 20% for three years, 15% for the following two years, and then slow to a constant rate of 10% thereafter. How much would an investor be willing to pay for this stock if her required return is 14%

Answer 1

Answer:

$38.33(approx)

Explanation:

Dividend for year 1 = 1 × 1.2

= $1.2

Dividend for year 2 = 1.2 × 1.2

= $1.44  

Dividend for year 3 = 1.44 × 1.2

=$1.728

Dividend for year 4 = 1.728 × 1.15

= $1.9872

Dividend for year 5=1.9872 × 1.15

= $2.28528

After year 5 value =(Dividend for year 5 × Growth rate) ÷ (Required rate-growth rate)

=($2.28528 × 1.1) ÷ (0.14 - 0.10)

=$62.8452

Current price = Future dividends × Present value of discount factor (14%,time period)

=1.2 ÷ 1.14 + 1.44 ÷ 1.14^2 + 1.728 ÷ 1.14^3 + $1.9872 ÷ 1.14^4 + $2.28528 ÷ 1.14^5 + $62.8450 ÷ 1.14^5

=$38.33(approx)