Question

Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 7%. Your company is about as risky as the average firm in the industry and just paid a dividend (D₀) of $2.25. You expect that the growth rate of dividends will be 50% during the first year (g_0,1 = 50%) and 20% during the second year (g_1,2 = 20%). After Year 2, dividend growth will be constant at 4%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

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Answer 1

Step - 1	Calculate Cost of equity	%
	Our stock has same risky as the average firm in the industry, so we can use industry growth & dividend yield for calculation of cost of equity.
	Cost of equity (Ke) = Dividend Yield + Growth Rate
	Ke = 7% + 4%	11%
Step - 2	Calculate Dividend for year 1 to 3	Amount
	Dividend
	D0 = as given	$2.25
	D1 = Dividend grow by 50%, so D1 = D0+D0*50%	$3.38
	D2 = Dividend grow by 20%, so D2 = D1+D1*20%	$4.05
	D3 = Dividend grow by 20%, so D3 = D2+D2*4%	$4.21
Step - 3	Estimated value per share at t2 = D3/ke-g	$60.17
Step - 4	Calculate Present Value (PV) of D1 & D2 + Estimated share Value
	PV D1	$3.04
	PV D2 & estimated share value at t2	$52.12
	Estimated Share Value at time 0	$55.16
	(Note :- Do not consider the D3 value because we calculated D3 only for calculation of estimated share value at time 2)