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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

jeff jeffy answered 2 days ago
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