Question

The SuperBowl Games Corp. paid a dividend of $1.00 per share on its common stock last year. However, the dividend is expected to grow by 20% for the next two years, 10% for the third year, before dropping to a constant 5% rate. If the required rate of return is 10%, what is the current price of the company's stock?

Answer 1

Since it is given the The SuperBowl Games Corp paid dividend of $1.00 per share last year, hence

Dividend for year 0 or at beginning of year 1 = D0 = $1

Dividend for year 1 = D1 = D0 (1+growth rate) = 1 (1+20%) = 1 x 1.20 = 1.20

Dividend for year 2 = D2 = D1(1+growth rate) 1.20(1+20%) = 1.20 x 1.20 = 1.44

Dividend for year 3 = D3 = D2(1+growth rate) 1.44(1+10%) = 1.44 x 1.10 = 1.584 = 1.58 (rounded to two decimal places)

Dividend in year 4 = D4= D3(1+growth rate) = 1.58(1+5%) = 1.58 x 1.05= 1.659 = 1.66 (rounded to two decimal places)

Constant growth of dividends after year 3 = g = 5% , Required rate of return of stock = r = 10%

If P3=Terminal value of stock at end of year 3, then according to constant growth rate model

P3 = D4 / (r - g) = 1.66 / (10% - 5%) = 1.66 / 5% = 33.20

Now P1 = Current price of stock,

P1 = D1/(1+r) + D2/(1+r)² + D3/(1+r)² + P3/(1+r)³

P1 = 1.20/(1+10%) + 1.44/(1+10%)² + 1.58/(1+10%)² + 33.20/(1+10%)³

P1 = 1.0909 + 1.1900 + 1.1870 + 24.9436 = 28.4115 = $28.41 (rounded to two decimal places)

Current price of company's stock = $28.41