Question

A7X Corp. just paid a dividend of $1.45 per share. The dividends are expected to grow at 25 percent for the next 6 years and then level off to a growth rate of 8 percent indefinitely.

If the required return is 15 percent, what is the price of the stock today?

Answer 1

Step-1, Dividend per share for the next 3 years

Dividend in Year 0 (D0) = $1.45 per share

Dividend in Year 1 (D1) = $1.8125 per share [$1.45 x 125%]

Dividend in Year 2 (D2) = $2.2656 per share [$1.8125 x 125%]

Dividend in Year 3 (D3) = $2.8320 per share [$2.2656 x 125%]

Dividend in Year 4 (D4) = $3.5400 per share [$2.8320 x 125%]

Dividend in Year 5 (D5) = $4.4250 per share [$3.5400 x 125%]

Dividend in Year 6 (D6) = $5.5313 per share [$4.4250 x 125%]

Step-2, Calculation of Stock Price for the Year 6(P6)

Dividend Growth Rate after 6^th year (g) = 8.00%

Required Rate of Return (Ke) = 15.00%

Stock Price for the Year 6 = D6(1 + g) / (Ke – g)

= $5.5313(1 + 0.08) / (0.15 – 0.08)

= $5.9738 / 0.07

= $85.34 per share

Step-3, The Current share price

The Current Stock Price is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 6

Year	Cash flow ($)	Present Value factor at 15.00%	Present Value of cash flows ($)
1	1.8125	0.86957	1.58
2	2.2656	0.75614	1.71
3	2.8320	0.65752	1.86
4	3.5400	0.57175	2.02
5	4.4250	0.49718	2.20
6	5.5313	0.43233	2.39
6	85.34	0.43233	36.89
TOTAL			48.66

“Hence, the Current Share Price will be $48.66”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.