Question

A fast growth has the first dividend (t=1) of $3.10. Dividends are then expected to grow at a rate of 8 percent p.a. for a further 4 years. it then will settle to a constant-growth rate of 1.8 percent. If the required rate of return is 19 percent, what is the current price of the share? (to nearest cent)

Answer 1

Calculation of price of the share using dividend discount model:

Given dividend is expected to grow for further five years at 8%, After that it will settle at a growth rate pf 1.8%,

Required rate of rate of return = 19%.

First year dividend = $3.10

Second year dividend = ($3.10+$3.10*8%) = $3.35

Third year dividend = ($3.35 + $3.35*8%) = $3.62

Fourth year dividend = ($3.62 + $3.62*8%) = $3.91

Fifth year dividend =($3.91 + $3.91*8%) = $4.22

Sixth year dividend = ($4.22 + $4.22*1.2%) = $4.27

Terminal value of the dividend = D6/(Ke-g)

Where D6 = Dividend for the 6th year

Ke = 19%, g= 1.2%

$4.27/(0.19-0.018) = $24.82

Price of the share = present value of 5 years dividend @19% + Present value of terminal value@19%

Calculation of Present value of 5years dividend:

Present value = $3.10*(0.840) + $3.35*(0.706) + $3.62*(0.593) + $3.91*(0.499) + $4.22*(0.419)

Present value = $10.84

Present value of terminal value:

Present value = $24.82*(0.419) = $10.40

So price of the share = $10.84 + $10.40 = $21.24.