Question

BlueCorp. is growing quickly. Dividends are expected to grow at a rate of 16 percent for the next three years, with the growth rate falling off to a constant 3.3 percent thereafter. If the required return is 12.49 percent and the company just paid a $3.27 dividend, what is the current share price? Answer to two decimals.

Answer 1

As per the Gordon growth model, the value of stock can be given as

Where D1 = Next year Dividend

V0 = Present Value

k = Stock's required return

g = Constant Dividend Growth rate

Now as after 3 years the dividend growth rate becomes constant at 3.3%, we can calculate the value of stock at the end of two years using the above formula

We will be require to calculate the 3rd year dividend

D3 = 3.27 * (1.16)3 = 5.104

Hence Value of stock can be given as

V2 = 55.538

Now we will calculate the dividends in year 1 and 2

D1 = 3.27 * 1.16 = 3.793

D2 = 3.27 * (1.16)2 = 4.40

Finally, we can sum the present values of dividends 1 and 2 and of V2 to get the present value of all the
expected future dividends during both the high- and constant growth periods

= 3.3718 + 2.9974 + 43.889

= 50.2582