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[Nonconstant Growth Model]  Desi Inc. recently paid a dividend, D0 = $1.25.  You expect their dividends to grow...

[Nonconstant Growth Model]  Desi Inc. recently paid a dividend, D0 = $1.25.  You expect their dividends to grow by 12% annually for the next 4 years.  After year 4, you expect the dividends to grow at a constant rate of 5% per year.  You require a 9% return on Desi’s stock.  What is the most you should be willing to pay for this stock?

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Expert Solution

$ 41.93

As per dividend discount model, current share price is the sum of present value of future dividends.
Step-1:Present value of dividends of next 4 years
Year Dividend Discount factor Present value
a b c=1.09^-a d=b*c
1 $ 1.4000 0.917431193 $                1.28
2 $ 1.5680 0.841679993 $                1.32
3 $ 1.7562 0.77218348 $                1.36
4 $ 1.9669 0.708425211 $                1.39
Total $                5.35
Step-2:Present value of dividends after year 4
Present value = D4*(1+g)/(Ke-g)*DF4 Where,
= $ 36.58 D4 = $                  1.9669
g = 5.0%
Ke = 9%
DF4 = 0.708425211
Step-3:Sum of present value of future dividends
Sum = $                               5.35 + $   36.58
= $                             41.93
So,
Price of stock is $    41.93

jeff jeffy answered 1 year ago
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