Question

You are evaluating Home Depot (HD) stock. The stock is expected to experience supernormal growth in dividends of 10 percent, g_s, over the next five years. Following this period, dividends are expected to grow at a constant rate of 3.5 percent, g. The stock paid a dividend of $5.5 last year, and the required rate of return on the stock is 12.62 percent. The fair present value of the stock is what?

Answer 1

The value is computed as follows:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + Dividend in year 4 / (1 + required rate of return)⁴ + Dividend in year 5 / (1 + required rate of return)⁵ + 1 / (1 + required rate of return)⁵ [ ( Dividend in year 5 (1 + growth rate) / ( required rate of return - growth rate) ]

= ($ 5.5 x 1.10) / 1.1262 + ($ 5.5 x 1.10²) / 1.1262² + ($ 5.5 x 1.10³) / 1.1262³ + ($ 5.5 x 1.10⁴) / 1.1262⁴ + ($ 5.5 x 1.10⁵) / 1.1262⁵ + 1 / 1.1262⁵ x [ ($ 5.5 x 1.10⁵ x 1.035) / (0.1262 - 0.035) ]

= $ 6.05 / 1.1262 + $ 6.655 / 1.1262² + $ 7.3205 / 1.1262³ + $ 8.05255 / 1.1262⁴ + $ 8.857805 / 1.1262⁵ + $ 100.5244317 / 1.1262⁵  

= $ 6.05 / 1.1262 + $ 6.655 / 1.1262² + $ 7.3205 / 1.1262³ + $ 8.05255 / 1.1262⁴ + $ 109.3822367 / 1.1262⁵

= $ 81.13 Approximately

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