Question

A company is planning on increasing its annual dividend by 7.50% a year for the next three years and then settling down to a constant growth rate of 2.50% per year in perpetuity. The company just paid its annual dividend in the amount of $0.80 per share. What is the current stock price if the required rate of return is 17.50%?

	$6.20
	$6.36
	$6.51
	$6.67
	$6.82

Answer 1

D1=(0.8*1.075)=0.86

D2=(0.86*1.075)=0.9245

D3=(0.9245*1.075)=0.9938375

Value after year 3=(D3*Growth rate)/(Required return-Growth rate)

=(0.9938375*1.025)/(0.175-0.025)

=6.79122292

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

=0.86/1.175+0.9245/1.175^2+0.9938375/1.175^3+6.79122292/1.175^3

=$6.20(Approx).