Question

A company currently pay a dividend $3.6 per share. It is estimated that the company's dividend will grow at a rate of 24% per year for the next two years and then at a constant rate of 8% thereafter. The company stock has a beta of 1.4, then the risk free rate is 9%, and the market risk premium is 5.5%. What is your estimate of the stock's current price

Answer 1

Step 1: Find required rate of return.

We can use required rate of return to find the present value.

Step 2: Find D1, D2 and D3

Where,
D₁ = Dividend on year 1
D₀ = Current dividend
g = growth rate

Step 3: Find value of stock on year 3.

V3 = Value of stock on year 3
k = Required rate of return
g = growth rate.

Step 4: Find present value of D1, D2 and V3. Sum of these will be the current stock price.

V = Current stock price

Substituting the values, we get:

Note: Common mistake students do while calculating the value of stock is that, while calculating present value of V₃ they use 3 discounting period instead of 2.