Question

1. RRR Co. just paid a dividend of $1.15 per share. The dividend is expected to grow by 40% next year, 20% in both Years 2 & 3, 10% in Year 4, and then grow at a constant rate of 4% thereafter. The required rate of return is 8.5%. Compute the selling price of the stock.

Answer 1

As per dividend discount model, current price of stock is the present value of future dividends.
Step-1:Present value of dividends of next 4 years
Year	Dividend	Discount factor	Present value
a	b	c=1.085^-a	d=b*c
1	$       1.61	0.921659	$       1.48
2	$       1.93	0.849455	$       1.64
3	$       2.32	0.782908	$       1.82
4	$       2.55	0.721574	$       1.84
Total			$       6.78
Working:
Dividend of Year:
1	=	$       1.15	*	1.4	=	$       1.61
2	=	$       1.61	*	1.2	=	$       1.93
3	=	$       1.93	*	1.2	=	$       2.32
4	=	$       2.32	*	1.1	=	$       2.55
Step-2:Present value of dividend after year 4
Present value	=	D4*(1+g)/(K-g)*DF4		Where,
	=	$    42.53		D4	$       2.55
				g	4%
				K	8.50%
				DF4	0.721574
Step-3:Sum of present value of future dividends
Sum of present value of future dividends	=	$       6.78	+	$    42.53
	=	$    49.31
So, price of stock is		$    49.31