Question

Please show all work and include:  i) timeline, ii) equation set up, iii) answer visibly circled or highlighted.

A tech start-up company has just become public. It just paid $3 dividend per share, which will grow 10% for the next two dividends. Afterwards, the dividends will level off and grow at 4% per year forever. If the investors require 6% return on similar investments, what is the price of stock?Answer:

Answer 1

Current Dividend = $3

Dividend in year 1 = Current Dividend * (1 + growth rate)

Dividend in year 1 = $3 * (1 + 10%)

Dividend in year 1 = $3.30

Dividend in year 2 = Dividend in year 1 * (1 + growth rate)

Dividend in year 2 = $3.30 * (1 + 10%)

Dividend in year 2 = $3.63

Dividend in year 3 = Dividend in year 3 * (1 + growth rate)

Dividend in year 3 = $3.63 * (1 + 4%)

Dividend in year 3 = $3.7752

Timeline

Time	0	1	2	3
Dividend	$3	$3.30	$3.63	$3.7752

Stock Price in year 2 = Dividend in year 3 / (Required return - growth rate)

Stock Price in year 2 = $3.7752 / (6% - 4%)

Stock Price in year 2 = $188.76

Stock price today = Dividend in year 1 / (1 + Required return) + Dividend in year 2 / (1 + Required return)² + Stock Price in year 2 / (1 + Required return)²

Stock price today = $3.30 / (1 + 6%) + $3.63 / (1 + 6%)² + $188.76 / (1 + 6%)²

Stock price today = $174.34