What should the stock price be if the current dividend is $1.00, the required return is...

What should the stock price be if the current dividend is $1.00, the required return is 15%, the growth rates years 1-3 are 6%, 8%, 9%. and 6% from year 4 on?

Expert Solution

Calculation of the stock price :-

Stock price means present value of all cash inflows from the stock.

Here growth is are non constant upto 3 years. From the year 4 growth rate is constant.

So we calculate the present value of all dividend from year 4 onwards is calculated at end of the year 3 that is terminal value of dividends.

Year	growth rate	dividend	Calculation
1	6%	$1.06000000	1 * 1.06
2	8%	$1.14480000	1.06 * 1.08
3	9%	$1.24783200	1.1448*1.09
4	6%	$1.32270192	1.247832 * 1.06

Terminal value of dividends from year 4 onwards at end of the year 3 = Year 4 dividend / (r - g)

year 4 dividend = 1.32270192 per share

r = required rate of return = 15%

g= growth rate forever from year 4 = 6%

= 1.32270192 / ( 0.15 - 0.06)

Terminal value at end of year 3 = $ 14.696688

Calculation of the stock price :-

years	Cash inflows	terminal value	Total cash inflows	PVF@15%	PV
1	$1.06000000		$1.06000000	0.869565	$0.921739130434783
2	$1.14480000		$1.14480000	0.756144	$0.865633270321361
3	$1.24783200	14.696688	$15.94452000	0.657516	$10.483780718336500
Stock price	$12.271153119092600
Stock price (Round off to two decimals)	$12.27

jeff jeffy answered 2 years ago

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