Question

A company issued a dividend of $1.00 (D₀) this year, which is expected to grow at 15% per year for the next 2 years and 5% per year thereafter. The required rate of return is 15% per year. Use the two-growth dividend discount model to complete the following table.

Item	Value
N
rs	%
g1	%
g2	%
D0	$1.00
D1	$
D2	$
D3	$
P0	$

Answer 1

Given information:

rs = 15%

g1 = 15%

g2 = 5%

D0 = $1.00

D1 = D0 * ( 1 + g1) = 1.00 * (1+0.15) = $1.15

D2 = D1 * ( 1 + g1) = 1.15 * ( 1+0.15) = $1.32

D3 = D2 * ( 1 + g2) = 1.32 * (1+0.05) = $1.39 (The dividend growth rate changes in the third year, hence g2 is used instead of g1)

P0 = PV of dividends paid for next 2 years + PV of stock calculated using Gordon's constant growth model at the end of year 2.

= D1 / (1+rs) + D2 / (1+rs)² + [ D3 / (r-g2) ] / (1+rs)²

= 1.15 / (1+0.15) + 1.32 / (1+0.15)² + [ 1.39 / (0.15-0.05) ] / (1+0.15)²

= $12.50

The completed table is given below

Item	Value
N	infinity
rs	15%
g1	15%
g2	5%
D0	$1.00
D1	$1.15
D2	$1.32
D3	$1.39
P0	$12.50