Question

Ram Corp's last dividend was $1.75 (D₀). Its dividend growth rate is expected to be at 25% for each of the first 2 years, after which dividends are expected to grow at a constant rate of 6% forever. Its required rate of return is 14%. What is its stock price?

	A) $32.76
	B) $30.48
	C) $35.45
	D) $31.90
	E) $34.60

Answer 1

Solution:-

DPS0 = $1.75

DPS1 = DPS0 * (1+G)

DPS1 = $1.75 * (1+0.25)

DPS1 = $2.1875

DPS2 = DPS1 * (1+G)

DPS2 = $2.1875 * (1+0.25)

DPS2 = 2.7344

To Calculate Terminal Value at the year end 2-

Terminal Value = $\frac{DPS2 * (1+G)}{Required Return - Growth Rate}$

Terminal Value = $\frac{2.7344 * (1+0.06)}{0.14 - 0.06}$

Terminal Value = $36.231

To Calculate Stock Price-

Stock Price = $\frac{DPS1}{(1+r)^{1}} + \frac{DPS2 + Terminal Value}{(1+r)^{2}}$

Stock Price = $\frac{2.1875}{(1+0.14)^{1}} + \frac{2.7344 + 36.231}{(1+0.14)^{2}}$

Stock Price = 2.1875 * 0.877 + 38.9654 * 0.769

Stock Price = $1.91886 + $29.98

Stock Price = $31.90

The Correct Answer is point D i.e. $31.90

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