Question

Suppose a firm is expected to increase dividends by 5% in one year and by 10% in year two. After that, dividends will increase at a rate of 4% per year indefinitely. If the last dividend was $4 and the required return is 10%, what is the price of the stock?

Answer 1

D1=(4*1.05)=4.2

D2=(4.2*1.1)=4.62

Value after year 2=(D2*Growth rate)/(Required return-Growth rate)

=(4.62*1.04)/(0.1-0.04)

=80.08

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=4.2/1.1+4.62/1.1^2+80.08/1.1^2

=$73.82(Approx)