Question

A company’s last dividend was $1.50 per share at the end of the year. For the next three years, the growth rate is expected to be 23% per year, after which the growth rate is expected to continue at a constant rate of 7% per share. Shareholders require 12% rate of return. What would you be willing to pay for this stock today? Show the answer by hand not using excel.

Answer 1

As per dividend discount method, price of stock is the present value of future dividends.
Step-1:Present value of next 3 year's dividend
	Year	Dividend	Discount factor		Present Value
	1	$       1.85	0.8929		$               1.65
	2	$       2.27	0.7972		$               1.81
	3	$       2.79	0.7118		$               1.99
	Total				$               5.44
	Working:
	Year	Last year dividend		Current Year dividend
	1	$       1.50		$       1.85
	2	$       1.85		$       2.27
	3	$       2.27		$       2.79
Step-2:Present value of after year 3's dividend
	Present Value		=	(D3*(1+g)/(Ke-g))*DF3			Where,
			=	(2.79*(1+0.07)/(0.12-0.07))*.7118			D3	$       2.79
			=	$    42.50			g	7%
							Ke	12%
							DF3	0.7118
Step-3:Present value of all future dividends
	Present Value		=	$       5.44	+	$    42.50
			=	$    47.94
Thus,Price of Stock today that should be paid				$    47.94