Question

The last dividend paid by Coppard Inc. was $1.40. The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (r s) is 12%, what is its current stock price?

Answers: a. $29.52 b. $32.49 c. $31.20 d. $33.50 e. $34.50

Answer 1

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

Cash flows from stock are dividends and Value of the stock with constant growth rate

Dividends :

Dividend after one year (D1) = Current dividend x (1 + Growth rate)

= $1.40 x 1.15

= $1.61

Similarly, D2 = $1.61 x 1.15

= $1.85

D3 = $1.85 x 1.15

= $2.13

Price of the stock at the end of 3^rd year

= D4 / (Re – G)

= D3 x (1 + Growth) / (Re – G)

= ($2.13 x 1.06) / (0.12 – 0.06)

= $37.62

The following table shows the calculation of price

Present value factor

= 1 / (1 + r) ^ n

Where,

r = 12% or 0.12

n = Years = 1 to 3

So, PV Factor for year 2 will be

= 1 / (1.12^2)

= 1 / 1.2544

= 0.797194

Calculations	A	B	C = A x B
Particulars
Years	Cash Flows	PV Factor	Present Values
1	1.61	0.892857	1.44
2	1.85	0.797194	1.48
3	2.13	0.71178	1.52
3	37.62	0.71178	26.77
		Price	31.20

So, as per above calculations, option c is the correct option