Question

A stock paid its annual dividend of $4.75 per share last week. This dividend is expected to grow at 20 percent per year for two years. Thereafter, the dividend growth rate is expected to be constant at 5 percent per year indefinitely. If the appropriate discount rate for the stock is 12 percent, what should the stock's price be today?

Answer 1

The stock current price is computed as shown below:

= Dividend in year 1 / (1 + discount rate)¹ + Dividend in year 2 / (1 + discount rate)² + 1 / (1 + discount rate)² [ ( Dividend in year 2 (1 + growth rate) / ( discount rate - growth rate) ]

= ( $ 4.75 x 1.20 ) / 1.12¹ + ( $ 4.75 x 1.20² ) / 1.12² + 1 / 1.12² [ ( $ 4.75 x 1.20² x 1.05) / ( 0.12 - 0.05 ) ]

= $ 5.70 / 1.12 + $ 6.84 / 1.12² + $ 102.6 / 1.12²

= $ 92.33 Approximately

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