Question

Consider four different stocks, all of which have a required return of 18.75 percent and a most recent dividend of $3.20 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 10 percent, 0 percent, and –5 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 20.75 percent for the next two years and then maintain a constant 12 percent growth rate, thereafter. What is the price for each of these four stocks?

Answer 1

Stock W:
Price of stock	=	D0*(1+g)/(Ke-g)	Where,
	=	3.20*(1+0.10)/(0.1875-0.10)	D0	=	$       3.20
	=	$    40.23		g	=	10%
				Ke	=	18.75%
Stock X:
Price of stock	=	D0*(1+g)/(Ke-g)	Where,
	=	3.20*(1+0.00)/(0.1875-0.00)	D0	=	$       3.20
	=	$    17.07		g	=	0%
				Ke	=	18.75%
Stock Y:
Price of stock	=	D0*(1+g)/(Ke-g)	Where,
	=	3.20*(1-0.05)/(0.1875+0.05)	D0	=	$       3.20
	=	$    12.80		g	=	-5%
				Ke	=	18.75%
Stock Z:
Price of dividend of next 2 years:
Year	Dividend	Discount factor	Present Value
a	b	c=1.1875^-a	d=b*c
1	$       3.86	0.842105	$       3.25
2	$       4.67	0.709141	$       3.31
Total			$       6.56
Present Value of dividend s aftr year 2	=	D2*(1+g)/(Ke-g)*DF2	Where,
	=	$    54.90			D2	=	$       4.67
					g	=	12%
					Ke	=	18.75%
					DF2	=	0.709141
Sum of present value of dividends	=	$       6.56	+	$    54.90
	=	$    61.46
So, Price of Stock Z	=	$    61.46