Question

A stock analyst believes a firm that is currently in financial trouble will soon recover. The analyst believes that the firm will continue paying a constant dividend of $0.52 per quarter for the next 3 years (next 12 quarters). However, after that point in time the analyst will estimate stock value as if the dividend will grow forever at a rate of 4.4% APR compounded quarterly. What is the analysts stock price estimate if using a required return of 16% APR compounded quarterly?

Answer 1

Price of the stock, under Dividend Discount Model, equals the present value of all future dividend payments.

Stock Price = Present Value of all future dividends = $16.20

Note:

1. Perpetual Dividend = Dividend after 12th quarter / (Required rate of return - Growth rate)

Dividend after 12th quarter = (Dividend at 12th quarter * (1+ growth rate / 4)) = ($0.52*(1+(4.4%/4)) = $0.526

Required rate of return = 16%/4 = 4%

Growth rate = 4.4%/4 = 1.1%