Question
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8. Zweite Pharma is a fast-growing drug company. Management forecasts that in the next three years,...
8. Zweite Pharma is a fast-growing drug company. Management forecasts that in the next three years, the company’s dividend growth rates will be 30 percent, 28 percent, and 24 percent, respectively. Last week it paid a dividend of $1.67. After three years, management expects dividend growth to stabilize at a rate of 8 percent. The required rate of return is 14 percent. (9 points)
a. Calculate expected dividends for each of the next three years, and calculate their present value. (3 points)
b. Calculate the price of the stock at the end of year 3, when the firm settles to a constant-growth rate. (3 points)
c. What is the current price of the stock? (3 points)
Solutions
Expert Solution
| Amount of Dividend | Present value | |
| D1 | 2.1710 | 1.9044 |
| D2 | 2.7789 | 2.1383 |
| D3 | 3.4458 | 2.3258 |
| Price of stock = Expected Dividend in Year 4/(Required Rate of return - growth rate) | ||
| =3.4458*(1+8%)/(14%-8%) | ||
| =$62.02 | ||
| Current price = Present value of all future inflows | ||
| =1.9043+2.1383+2.3258 + 62.02/(1.14)^3 | ||
| =$48.23 per share | ||
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