Question

Synovec Co. is growing quickly. Dividends are expected to grow at a rate of 27 percent for the next 3 years, with the growth rate falling off to a constant 6 percent thereafter.

If the required return is 14 percent and the company just paid a $1.50 dividend. what is the current share price?

• $33.75

• $31.01

• $32.42

• $33.09

• $29.71

Answer 1

Step-1, Dividend for the next 3 years

Dividend in Year 0 (D0) = $1.50 per share

Dividend in Year 1 (D1) = $1.9050 per share [$1.50 x 127%]

Dividend in Year 2 (D2) = $2.4194 per share [$1.9050 x 127%]

Dividend in Year 3 (D3) = $3.0726 per share [$2.4194 x 127%]

Step-2, The Price of the stock in year 3(P3)

The Share Price in year 3 (P3) = D3(1 + g) / (Ke – g)

= $3.0726(1 + 0.06) / (0.14 – 0.06)

= $3.2569 / 0.08

= $40.71 per share

Step-3, Current Price of the common stock

As per Dividend Discount Model, The Current Price per share is the aggregate of the Present Value of the future dividend payments and the present value the share price in year 3

Year	Cash flow ($)	Present Value factor at 14.00%	Present Value of cash flows ($)
1	1.9050	0.87719	1.67
2	2.4194	0.76947	1.86
3	3.0726	0.67497	2.07
3	40.71	0.67497	27.48
TOTAL			33.09

“Hence, the Current Price will be $33.09”

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.