Question

Yue Integrated Circuits, Inc. common stock currently pays a $1.50 annual dividend (D0). You expect Yue dividends to grow at a 10% annual rate for the next two years, and a 5% constant rate thereafter (after year two). Assume investors expect a 12% rate of return on Yue common stock. What is the price (value) forecast of the common stock at the end of year 2

Answer 1

Based on the dividends and the growth rate, we can infer that the value of the stock at the end of year 2 is $27.26

You can use the Gordon Growth Model to solve for this:

Value of stock = Next dividend / (Rate of return - growth rate)

Next dividend = Dividend in year 3:

= Current dividend x (1 + year 1 growth) x (1 + year 2 growth) x ( 1 + year 3 growth)

= 1.50 x (1 + 10%) + (1 + 10%) + (1 + 5%)

= $1.90575

Value of stock₂ = 1.90575 / (12% - 5%)

= $27.26

In conclusion, the value of the stock at the end of year 2 is $27.26

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