Question

Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 41.00% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (r_s) is 12%. What is the best estimate of the current stock price?

Select the correct answer.

a. $50.43

b. $52.79

c. $53.97

d. $51.61

e. $49.25

Answer 1

c. $53.97

As per dividend discount model, current price of stock is the present value of future dividends.
Step-1:Present value of dividend of next 2 years
Year	Dividend	Discount factor	Present value
a	b	c=1.12^-a	d=b*c
1	$       2.47	0.8929	$       2.20
2	$       3.48	0.7972	$       2.77
Total			$       4.98
Working;
Dividend of year :
1	=	$       1.75	x	1.41	=	$       2.47
2	=	$       2.47	x	1.41	=	$       3.48
Step-2:Present value of dividends after year 2
Present value		=	D2*(1+g)/(K-g)*DF2			Where,
		=	3.48*(1+0.06)/(0.12-0.06)*0.7972			D2	$        3.48
		=	$    49.01			g	6%
						K	12%
						DF2	0.7972
Step-3:Present value of all dividends
Present value of future dividends				=	$       4.98	+	$     49.01
				=	$    53.99
Note:
Difference of $ 0.02 is due to rounding off difference.