Question

- Holtzman Clothiers's stock currently sells for $39.00 a share. It just paid a dividend of $1.00 a share (i.e., D0 = $1.00). The dividend is expected to grow at a constant rate of 10% a year. What stock price is expected 1 year from now? What is the required rate of return?

- Carnes Cosmetics Co.'s stock price is $35, and it recently paid a $2.00 dividend. This dividend is expected to grow by 21% for the next 3 years, then grow forever at a constant rate, g; and r_s = 15%. At what constant rate is the stock expected to grow after Year 3?

Answer 1

1. Stock Price one year from now =Current Stock Price*(1+Growth)=39*(1+10%) =42.90
Required Rate =Dividend Yield +Capital Gain =Dividend*(1+g)/Current Stock Price+Growth =1*(1+10%)/39+10% =12.8205% or 12.82%

2. Dividend in year 1 =Current Dividend*(1+g) =2*(1+21%) =2.42
Dividend in year 2 =Current Dividend*(1+g)^2 =2*(1+21%)^2 =2.9282
Dividend in year 3 =Current Dividend*(1+g) =2*(1+21%)^3 =3.543122
Terminal Value =Dividend Year 3*(1+g)/(Required Rate-growth) =3.543122*(1+g)/(15%-g)
Price of Bond =Dividend Year 1/(1+r)+Dividend Year 2/(1+r)^2+Dividend Year 3/(1+r)^3+Terminal Value/(1+r)^3
35 =2.42/(1+15%)+2.9282/(1+15%)^2+3.543122/(1+15%)^3+Terminal Value/(1+15%)^3
Terminal Value/1.15^3=28.35185
Terminal Value =28.35185*1.15^3 =43.1196

43.1196 =3.543122*(1+g)/(15%-g)
43.1196*15%-43.1196*g=3.543122+3.543122*g
growth after 3 years =(43.1196*15%-3.543122)/(43.1196+3.543122) =6.2680% or 6.27%