Question

. A company is a fast growing technology company. The firm projects a rapid growth of 40 percent for the next two years and then a growth rate of 20 percent for the following two years. After that, the firm expects a constant-growth rate of 12 percent. The firm expects to pay its first dividend of $1.25 a year from now. If your required rate of return on such stocks is 20 percent, what is the current price of the stock? A. $30.30 B. $15.63 C. $21.70 D. $22.68 E. $18.06

Please preface solution with any financial formulas used and show work. Thank you

Answer 1

Present value = Future value/(1+i)^n

i = interest rate per period

n= number of periods

value of stock = Present value of dividends + Horizontal value

Horizontal value = dividend next year/(Required return - growth rate)

=>

horizontal value = 1.25 * 1.4 * 1.2^2 * 1.12/(0.2-0.12)

= 35.28

value of stock = 1.25/1.2 + 1.25*1.4/1.2^2 + 1.25*1.4*1.2/1.2^3 + 1.25*1.4*1.2^2/1.2^4 + 35.28/1.2^4

= 21.70

hence choose C)