Question

Morgan Company's last dividend (D0) was $1.40. Its dividend growth rate is expected to be constant at 24% for 2 years, after which dividends are expected to grow at a rate of 6% forever. If the company's required return is 12%, what is your estimate of its current stock price?

Your answer should be between 18.40 and 78.16.

Answer 1

estimate of its current stock price can be calculated using the following steps :-

1) explicit forcast period (year 1-2)

2) horizon period

3) conclusion

1) explicit forcast period (year 1-2)

growth= 24%

re(required return) =  12%

Here we can calculate the present value of cash flow for the first two years using the following formula :-

= {divident(y1) / 1+re¹} + {divident(y2) / 1+re²}

= (1.40*1.24¹) / 1.12 + (1.40*1.24² / 1.12²)

= (1.736 / 1.12 + (2.1526 / 1.2544)   

= (1.55 + (1.7161)

PRESENT VALUE FOR 2 YEARS = 3.2661

2)horizon period

growth= 6%

re(required return) =  12%

present value on end of 2nd year = divident 3rd year/ RE-G

=(1.40 * 1.24*1.24*1.06) / (0.12 - 0.06)

= 2.281 / 0.06

present value on end of 2nd year = 38.03

present value year 0 = 38.03 / (1.12)²

= 30.317

total present value = 3.2661 + 30.317 = 33.5831

the answer is 33.5831

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