Question

Problem 7: Using a dividend discount model, what is the true value of a stock that will pay a dividend of $3.00 one year from now. Assume that during the first stage the dividend grows at 75% for 3 years, so the end of stage one is t-3. In the second stage you expect the company to grow at 5% for the rest of its life. Use a discount rate of 18%

Answer 1

Year	Dividend
1	3.00
2	5.10
3	8.67
4	14.74

After year 4 dividend will grow in the form of an annuity, we need to find the PV of that annuity

Dividend discounting method is used to find the share present value by discounting the predicted dividend

Formula is,

Value of share = (Dividend per share/ Discount rate) -Dividend growth rate

Let's put all the values in the formula

= 15.477/ 0.18 -0.05

= 15.477/ 0.13

= 119.05

Year	Dividend	PV fctor @ 18%	PV of dividend
1	3.00	0.84746	2.54237
2	5.10	0.71818	3.66274
3	8.67	0.60863	5.27683
4	14.74	0.51579	7.60221
4	119.05000	0.51579	61.40467
		Total	80.48882

PV of stock = 80.49

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