Question

Nonconstant Dividend Growth Valuation

A company currently pays a dividend of $3.6 per share (D0 = $3.6). It is estimated that the company's dividend will grow at a rate of 16% per year for the next 2 years, and then at a constant rate of 6% thereafter. The company's stock has a beta of 1.6, the risk-free rate is 8.5%, and the market risk premium is 5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 8.5 + 1.6 * (5)

Expected return% = 16.5

	Required rate=	16.50%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	3.6	16.00%	4.176		4.176	1.165	3.5845
2	4.176	16.00%	4.84416	48.903	53.74716	1.357225	39.60077
	Long term growth rate (given)=	6.00%			Value of Stock =	Sum of discounted value =	43.19
Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 2 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor