Microsoft just paid an annual dividend of $2. Analysts expect that the company will
increase dividends at a rate of 13% per year during the next three years, and then increase
at a constant rate of 4% forever. If the discount rate of Microsoft is 15%, what is the
current price of the stock?
D1=(2*1.13)=2.26
D2=(2.26*1.13)=2.5538
D3=(2.5538*1.13)=2.885794
Value after year 3=(D3*Growth rate)/(Discount rate-Growth rate)
=(2.885794*1.04)/(0.15-0.04)
=27.2838705
Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)
=2.26/1.15+2.5538/1.15^2+2.885794/1.15^3+27.2838705/1.15^3
=$23.73(Approx).
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