Question

A financial analyst has been following Davis Inc., a new high-tech firm. He estimates that the current risk-free rate (r_F) is 6.25%, the market risk premium (r_M - r_F) is 5%, and the firm’s beta is 1.75. The current dividend just paid (D₀) is $1.00. The analyst estimates that the company’s dividend will grow at a rate of 25% this year, 20% next year, and 15% the following year. After three years the dividend is expected to grow at a constant rate of 7% a year. The analyst believes that the stock is fairly priced. What’s the horizon value (terminal value) of the stock at the end of year 3 for the constant growth period?

		$23.07
		$23.83
		$25.42
		$26.85

calculate the current price of the stock.

		$15.62
		$17.21
		$18.53
		$19.83

Answer 1

r or cost of equity=6.25%+1.75*5%=15.00%

What’s the horizon value (terminal value) of the stock at the end of year 3

=(1.00*(1+25%)*(1+20%)*(1+15%)*(1+7%))/(15.00%-7%)

=23.07

the current price of the stock

=(1.00*(1+25%))/(1+15.00%)^1+(1.00*(1+25%)*(1+20%))/(1+15.00%)^2+(1.00*(1+25%)*(1+20%)*(1+15%))/(1+15.00%)^3+((1.00*(1+25%)*(1+20%)*(1+15%)*(1+7%))/(15.00%-7%))/(1+15.00%)^3

=18.53