The last dividend of the common stock of Acme Co. was $2.50 per share. Suppose the...

Question

Question

The last dividend of the common stock of Acme Co. was $2.50 per share. Suppose the expected growth rate for the next two periods is 18% and 5% indefinitely after that and that you require a return of 15% for assets like this?
1. Draw a timeline for this stock over 3 years, label the cashflows.
2. What are the dividends paid in each of the next 3 years?
3. What is the expected price of the stock in year 2?
4. According to the dividend discount model, what is the value of a share of Acme stock?

Answer 1

Answer #1

D₁ = 2.50(1.18) = $2.95

D₂ = 2.50(1.18)² = $3.48

D₃ = 2.50(1.18)²(1.05) = $3.66

Using DDM Model,

Stock Price in year 2 = 3.66/(0.15 - 0.05)

Stock price in Year 2 = $36.60

Value of Stock = 2.95(1.15) + (3.48 + 36.60)/(1.15)²

Stock Price = $32.87

Answer 2

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