Question

Problem 7-12
Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 5% and that its dividend yield is 7%. 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 5%. 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 your answer to the nearest cent.

Answer 1

required rate of return on the stock = dividend yield + growth rate

required rate of return = 7% + 5% = 12.00%

rate	12.0000%
Cash flows	Year	Discounted CF= cash flows/(1+rate)^year
-	0	-
2.63	1	2.34
3.15	2	2.51
47.25	2	37.67

Terminal value = 3.15*1.05/(0.12-0.05) = 47.25

price of the stock = 42.52