Question

Nonconstant Dividend Growth Valuation A company currently pays a dividend of $1.8 per share (Do = $1.8). It is estimated that the company's dividend will grow at a rate of 15% per year for the next 2 years, and then at a constant rate of 6% thereafter. The company's stock has a beta of 1.8, the risk-free rate is 7.5%, and the market risk premium is 2.5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

7.50% 2.50% Risk free rate Market risk premium Beta Required rate of return 1.8 12.00% Last Dividend D(0) Growth rate (0,2) Growth rate (2, thereafer) $1.80 15% 6% Year 1 Dividend $2.07 $2.38 $2.52 Present value of first two dividends Terminal value Present value of Terminal value $3.75 $42.06 $33.53 O Stock's current price $37.27

Cell reference -

А . B 0.075 0.025 Risk free rate Market risk premium Beta Required rate of return 1.8 =C2+C3*C4 1.8 Last Dividend D(0) Growth rate (0,2) Growth rate (2, thereafer) 0.15 0.06 Year Dividend 1 =C7*(1+C8) =C12*(1+C8) =C13*(1+C9) 3 Present value of first two dividends =NPV(C5,C12:C13) Terminal value =C14/C5-C9) Present value of Terminal value =C17/(1+C5)^2 Stock's current price =C16+C18

Please note: Required rate of return calculated with CAPM equation.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.