Nonconstant Dividend Growth Valuation
A company currently pays a dividend of $3.6 per share (D0 = $3.6). It is estimated that the company's dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.8, the risk-free rate is 7.5%, and the market risk premium is 3.5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.
Required rate of return as per CAPM = Risk free rate + beta*market risk premium
= 7.5% + 1.8*3.5%
= 13.8%
Value of stock is equal to present value of all future dividends
= 3.6(1+20%)/(1.138) + 3.6(1.2)^2/(1.138)^2 + 3.6(1.2)^2(1.07)/(1.138)^2(13.8%-7%)
= $70.7867
i.e. $70.79
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