Question
In: Finance
You are planning to buy a stock that has just paid a dividend (D0) of $2.50....
You are planning to buy a stock that has just paid a dividend
(D0) of $2.50. In addition, you anticipate the following dividend
growth rates:
• Year 1 = 100%
• Year 2 = 0%
• Year 3 = -30% (note this is NEGATIVE 30%)
• Year 4 = 20%
• Years 5 through infinity = 4%
Assume a discount rate of 10%. Based on this, what is the value of
the stock today? (Hint: use the three-step process of non-constant
growth DDM).
Solutions
Expert Solution
| Required rate= | 10.00% | ||||||
| Year | Previous year dividend | Dividend growth rate | Dividend current year | Horizon value | Total Value | Discount factor | Discounted value |
| 1 | 2.5 | 100.00% | 5 | 5 | 1.1 | 4.5455 | |
| 2 | 5 | 0.00% | 5 | 5 | 1.21 | 4.13223 | |
| 3 | 5 | -30.00% | 3.5 | 3.5 | 1.331 | 2.6296 | |
| 4 | 3.5 | 20.00% | 4.2 | 72.8 | 77 | 1.4641 | 52.59204 |
| Long term growth rate (given)= | 4.00% | Value of Stock = | Sum of discounted value = | 63.9 | |||
| Where | |||||||
| Current dividend =Previous year dividend*(1+growth rate)^corresponding year | |||||||
| Total value = Dividend + horizon value (only for last year) | |||||||
| Horizon value = Dividend Current year 4 *(1+long term growth rate)/( Required rate-long term growth rate) | |||||||
| Discount factor=(1+ Required rate)^corresponding period | |||||||
| Discounted value=total value/discount factor |
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