Question

Company A paid $0.5 dividend per share last year. The dividend will be growing at 30% for three more years and will drop to 10% and remain indefinitely. Calculate the value of the share today if the required rate of return of the shares is 20%.

Answer 1

Year 1 Dividend = 0.5*1.3 = 0.65

Year 2 Dividend = 0.65*1.3 = 0.845

Year 3 Dividend = 0.845*1.3 = 1.0985

Year 4 Dividend = 1.0985*1.1 = 1.20835

Thereafter dividend will grow by 10% till infinite

So using single stage Dividend growth formula to find the stock value at year 3,

Stock Value at year 3 = Next Year dividend/(required rate of return - growth)

Stock Value at year 3 = 1.20835/(0.2 - 0.1) = 12.0835

PV of the stock = dicounted value of all the future cash flows which are discounted by required return of 20% = 0.65/(1+0.2) + 0.845/{(1+0.2)^2} + 1.0985/{(1+0.2)^3} + 12.0835/{(1+0.2)^3} = $8.757

Hence the PV of stock is $8.757 approx