Question

McGaha Enterprises expects earnings and dividends to grow at a rate of 29% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

Answer 1

Current price of the common stock is $ 7.64

As per dividend discount model, current share price is present value of future dividends.

Year	Dividend	Discount factor	Present Value
a	b	c=1.096^-a	d=b*c
1	$       1.61	0.912409	$       1.47
2	$       2.08	0.83249	$       1.73
3	$       2.68	0.759571	$       2.04
4	$       3.46	0.693039	$       2.40
Total			$       7.64
So, current price of common stock is $ 7.64
Working:
As per Capital Asset Pricing Model,
Required return	=	Risk free rate	+	Beta	*	market risk premium
	=	3.00%	+	1.20	*	5.50%
	=	9.60%