Question

Nonconstant Growth Valuation A company currently pays a dividend of $1.25 per share (D0 = $1.25). It is estimated that the company's dividend will grow at a rate of 24% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company's stock has a beta of 1.3, the risk-free rate is 5%, and the market risk premium is 4%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Formula sheet

A1	B	C	D	E	F	G	H	I	J
2
3		Growth rate for two years	0.24
4		Terminal growth rate (gL)	0.05
5		D0	1.25
6
7
8		As per dividend growth model, Price of share is the present value of all future dividends discounted at cost of equity.
9
10		Cost of equity can be calculated using CAPM as follows:
11		As Per CAPM, Cost of equity can be calculated as
12		r(E) = rf + ?*(rm-rf)
13		Using the Following data
14		Beta (?)	1.3
15		Risk free rate ( rf )	0.05
16		Market Risk Premium (rm-rf)	0.04
17
18		Cost of equity can be calculated as follows:
19		Cost of equity	= rf + ?*(rm-rf)
20			=D15+D14*D16	=D15+D14*D16
21
22		Hence Cost of Equity is	=D20
23
24		Future dividends can be calculated as follows:
25		Year	0	1	2	3	4	…
26		Dividend	=D5	=D26*(1+$D$3)	=E26*(1+$D$3)	=F26*(1+$D$4)	=G26*(1+$D$4)	…
27
28		Calculation Price of the share at Year 0
29		Required return	=D22
30		Year	0	1	2	3	4	…
31		Dividend		=E26	=F26	=G26	=H26	…
32		Terminal value = DIV3/(rs-gL)			=G31/(D29-D4)
33		Present value of dividends		=(E31+E32)/((1+$D$29)^E30)	=(F31+F32)/((1+$D$29)^F30)
34		Price of share at Year 0	=SUM(E33:F33)	=SUM(E33:F33)
35
36		Hence Price of share at Year 0 is	=D34
37