Question

A company is planning on increasing its annual dividend by 8.75% a year for the next three years and then settling down to a constant growth rate of 3.75% per year in perpetuity. The company just paid its annual dividend in the amount of $1.05 per share. What is the current stock price if the required rate of return is 18.75%?
Question 8 options: $7.82
$8.02
$8.23
$8.43
$8.64

Answer 1

C.$8.23

present value factor = 1 /(1+r)^n

year	dividend	present value factor	dividend * present value factor
1	$1.05 +8.75%=>$1.141875	1/(1.1875)^1=>0.84211	$0.9616
2	$1.141875+8.75% =>$1.24179	1/(1.1875)^2=>0.70914	$0.8806
3	$1.24179+8.75%=>$1.35045	1/(1.1875)^3=>0.59717	$0.80645
3	$9.3406 (see working)	1/(1.1875)^3=>0.59717	$5.57793
		Total	$8.23

working;

horizon value at end of year 3 = $1.35045 *(1+ growth rate) / (required return - growth rate)

=> $1.35045 *(1.0375) / (0.1875-0.0375)

=>$1.401091875 / 0.15

=>$9.3406