Question

You are analyzing the stock of Pizza Hub, an online pizza delivery company. Your estimate of...

You are analyzing the stock of Pizza Hub, an online pizza delivery company. Your estimate of the cost of equity is 16 percent. The most recent dividend is $0.20 per share. You expect dividends to grow 15 percent per year for three years and 8 percent per year thereafter. What is your estimate of the stock price?

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Answer #1

Dividend in year 1, D1= D0 x (1+g) = $ 0.2 x (1+0.15) = $ 0.2 x 1.15 = $ 0.23

Dividend in year 2, D2= D1 x (1+g) = $ 0.23 x (1+0.15) = $ 0.23 x 1.15 = $ 0.2645

Dividend in year 3, D3= D2 x (1+g) = $ 0.2645 x (1+0.15) = $ 0.2645 x 1.15 = $ 0.304175

Dividend in year 4, D4= D3 x (1+g) = $ 0.304175 x (1+0.08) = $ 0.304175 x 1.08 = $ 0.328509

As per Dividend Discount Model stock price in year 3 can be computed as:

P3 = D4/(r – g)

r = cost of capital = 16 % or 0.16

g = Constant growth rate of dividend = 8 % or 0.08

     P 3 = $ 0.328509/ (0.16 – 0.08)

     = $ 0.328509/0.08

      = $ 4.1063625

Current stock price P0 = D1 / (1+r) + D2 / (1+r) 2 + D3 / (1+r) 3 + P3 / (1+r) 3

  = $ 0.23 / (1+0.16) + $ 0.2645 / (1+0.16) 2 + D3 / (1+0.16) 3 + P3 / (1+0.16) 3

= $ 0.23 / (1.16) + $ 0.2645 / (1.16) 2 + $ 0.304175/ (1.16) 3 + $ 4.1063625/ (1.16) 3

= $ 0.23 /1.16 + $ 0.2645 / 1.3456 + $ 0.2645/ 1.560896 + $ 4.1063625/ 1.560896

= $ 0.198275862068966 + $ 0.196566587395957 + 0.19487204784944 + 2.63077264596744

= $ 3.22048714328181 or $ 3.22

Current stock price of Pizza Hub is $ 3.22

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