Question

Assume that Camilles Jewelry Corp. recently paid an annual dividend of $2.00 per share (or D0) on its common stock. Because of exceptionally positive operating results, the firm expects dividends to grow at a supernormal growth rate of 20% (or Gs) over the next three years. After the end of the three year supernormal growth period, dividend growth is expected to return to the firms normal rate of 6% (or Gn). The investors required return for Camilles Jewelry Corp. common stock is 12% (or Ke). Using the two-stage growth model solve for the firm's current stock price (or P0)

Show all your work.

Answer 1

Step-1, Dividend for the next 4 years

Dividend in Year 0 (D0) = $2.00 per share

Dividend in Year 1 (D1) = $2.4000 per share [$2.00 x 120%]

Dividend in Year 2 (D2) = $2.8800 per share [$2.40 x 120%]

Dividend in Year 3 (D3) = $3.4560 per share [$2.88 x 120%]

Step-2, The Price of the stock in year 4 (P4)

The Share Price in year 3(P3) = D4(1 + g) / (Ke – g)

= $3.4560(1 + 0.06) / (0.12 – 0.06)

= $3.6634 / 0.06

= $61.06 per share

Step-3, Current Price per share

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 ($)	Present Value factor at 12.00%	Present Value of cash flows ($)
1	2.4000	0.89286	2.14
2	2.8800	0.79719	2.30
3	3.4560	0.71178	2.46
3	61.06	0.71178	43.46
TOTAL			50.36

“Hence, the firm's current stock price (or P0) will be $50.36”

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.