A company currently pays a dividend of $3.25 per share (D0 = $3.25). It is estimated that the company's dividend will grow at a rate of 24% per year for the next 2 years, then at a constant rate of 5% thereafter. The company's stock has a beta of 1.9, the risk-free rate is 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.
| Step-1:Calculation of discount rate | |||||||
| As per Capital Asset Pricing model, | |||||||
| Discount rate | = | Risk free rate | + | Beta | * | Market risk premium | |
| = | 5% | + | 1.9 | * | 3% | ||
| = | 10.70% | ||||||
| Step-2:Calculation of Current price of stock | |||||||
| As per dividend discount model, current stock price is the present value of future dividends. | |||||||
| Present value of dividend of next 2 years | $ 7.72 | ||||||
| Present value of dividend after 2 years | $ 75.12 | ||||||
| Total Present value of cash flows | $ 82.84 | ||||||
| So, current price of stock is | $ 82.84 | ||||||
| Working: | |||||||
| Present value of dividend of next 2 years: | |||||||
| Year | Dividend | Discount factor | Present Value | ||||
| a | b | c=1.1070^-a | d=b*c | ||||
| 1 | $ 4.03 | 0.903342 | $ 3.64 | ||||
| 2 | $ 5.00 | 0.816027 | $ 4.08 | ||||
| Total | $ 7.72 | ||||||
| Present value of dividend after 2 years: | |||||||
| Present value | = | D2*(1+g)/(Ke-g)*DF2 | Where, | ||||
| = | $ 75.12 | D2 | = | $ 5.00 | |||
| g | = | 5% | |||||
| Ke | = | 10.70% | |||||
| DF2 | = | 0.816027 | |||||
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