Question

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $2. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 30% during the second year (g1,2 = 30%). After Year 2, dividend growth will be constant at 4%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Please find below solution..

Required rate = Growth rate + Dividend yield rate
Required rate =		=8%+4%		12.00%
Value of stock = present value of future cash flow
Dividend year 1 =	=2*(1+50%)		3.00
Dividend year 2 =	=3*(1+30%)		3.90
Dividend year 3 =	=3.90*(1+4%)		4.056
Computation of horizon value = Dividend in year 3/ (required rate - growth rate)
	=4.056/(12%-4%)
	50.70
Computation of share price
	i	ii	iii=i+ii	iv	v=iv*iii
Year	Dividend	Terminal value	Total cash flow	PVIF 12%	present value
1	3.00		3.00	0.8929	2.68
2	3.90	50.70	54.60	0.7972	43.53
					46.21
Price today =	46.21