Question

Assume that the average firm in your company's industry is expected to grow at a constant rate of 6% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $1.75. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 20% during the second year (g1,2 = 20%). After Year 2, dividend growth will be constant at 6%. What is the required rate of return on your company’s stock? What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round the monetary value to the nearest cent and percentage value to the nearest whole number.

Answer 1

Required return=dividend yield+growth rate

=(6+8)=14%

D1=(1.75*1.5)=2.625

D2=(2.625*1.2)=3.15

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

=(3.15*1.06)/(0.14-0.06)

=41.7375

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

=2.625/1.14+3.15/1.14^2+41.7375/1.14^2

=$36.84(Approx)