Question

A company currently pays a dividend of $2.25 per share (D₀ = $2.25). It is estimated that the company's dividend will grow at a rate of 15% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company's stock has a beta of 1.8, the risk-free rate is 5%, and the market risk premium is 5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Calculation of required return:
Required return= Risk free rate+beta*market risk premium
=5+1.8*5= 14%
Calculation of current price:
Year	Cashflows	PVF @14%	Present value
1	2.59	0.877	2.27
2	2.98	0.769	2.29
2	34.72	0.769	26.70
Total			31.26
Current price is $31.26
Working:
Dividend at year 1= 2.25*(1+0.15)= 2.59
Dividend at year 2= 2.59*(1+0.15)= 2.98
Terminal value= Dividend(1+growth)/(return-growth)
=2.98*(1+0.05)/(0.14-0.05)
=3.129/0.09=34.72