Question

New Gadgets, Inc., currently pays no dividend but is expected to pay its first annual dividend of $4.80 per share exactly 5 years from today. After that, the dividends are expected to grow at 3.3 percent forever. If the required return is 11.1 percent, what is the price of the stock today?

Answer 1

Answer:

The price of the stock today is $40.39

Explanation:

The price of the stock today can be calculated using the constant growth model of the DDM approach. The constant model is used whenever the expected dividend is expected to grow at a constant rate forever. The formula for price today is,

P0 = D1 / r -g

Where we use D1 that is dividend expected for the next year to calculate price today. As the company will pay dividend in the year 5 that is  D5, we will calculate the price using this model that will be price at Year 4 and dicount it back for 4 years to calculate the price today.

P0 = [4.8 / (0.111 - 0.033)] / (1+0.111)^4

P0 = $40.39