Question

Nonconstant Growth Valuation A company currently pays a dividend of $2 per share (D0 = $2). 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 5% thereafter. The company's stock has a beta of 1.25, the risk-free rate is 3.5%, and the market risk premium is 3%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Current Price = Present Value of Dividends+ Present Value of Price at Year 2

= $ 4.444009758695070 + $ 107.3094219947370

= $ 111.75

Hence the correct answer is $ 111.75

Notes:

1. Required return = risk free rate + (market risk premium *beta)

= 3.5% + (3% *1.25)

= 7.25%

2. Present Value of Dividends:

Year	Dividend	Discounting Factor(7.25%)	Present Value ( Dividend * Discounting factor)
0	2.00
1	2.30	0.9324009324009320	2.1445221445221400
2	2.645	0.8693714987421280	2.2994876141729300
Present Value of Dividends			4.444009758695070

3. Present Value of Price at Year 2 =[ (Expected Dividend) / ( Required return - growth rate) ]  * Discounting Factor at Year 2

= [ {$ 2.645 * (1.05)} /( 7.25%-5%) ] *0.8693714987421280

=$ 107.3094219947370