Question

Keep the Highest: 0/1 0 Attempts: 3. Problem 8-05 (Nonconstant Growth Valuation) eBook Nonconstant Growth Valuation A company currently pays a dividend of $2 per share (Do= $2) . It is estimated that the company's dividend will grow at a rate of 16 % per year for the next 2 years, and then at a constant rate of 5 % thereafter. The company's stock has a beta of 1.7, the risk-free rate is 9.5 % , and the market risk premium is 6 %. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent. Grade It New Save&Continue Continue without saving

Answer 1

The stocks current price is computed as shown below:

Required rate of return is computed as shown below:

= Risk free rate + Beta x Risk premium

= 0.095 + 1.7 x 0.06

= 19.7% or 0.197

Dividend at end of year 1 is computed as follows:

= $ 2 x 1.16

= $ 2.32

Dividend at end of year 2 is computed as follows:

= $ 2 x 1.16²

= $ 2.6912

Dividend at end of year 3 is computed as follows:

= $ 2.6912 x 1.05

= $ 2.82576

So the price will be:

= $ 2.32 / 1.197 + $ 2.6912 / 1.197² + 1 / 1.197² [ ( $ 2.82576 / ( 0.197 - 0.05 ) ]

= $ 17.23 Approximately

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