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Your firm just paid a dividend of $1.80 that you plan to raise by 50% per...

Your firm just paid a dividend of $1.80 that you plan to raise by 50% per year for the next three years and then grow at a constant rate of 6%. If investors require a return of 11%, what should be the current price of your stock?

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Expert Solution

D0 1.8
For the first two years
g1 0.5
D1 1.8*(1+.5)
D1 2.7
D2 2.7*(1+.5)
D2 4.05
D3 4.05*(1+.5)
D3 6.075
Find the price of the stock in year 3
g2 0.06
D4 6.075*(1+.06)
D4 6.4395
According to the dividend growth model.
P3 = D4/(R-g2)
where R is the required return on the stock.
R = .11.
P3 6.4395/(.11 - .06)
P3 128.79
Cash flow in year 3 P3 +D3
Cash flow in year 3 134.865
The price of the stock today = sum of present value of future cash flows.
Using R = .11
Year 1 2 3
Cash flow 2.7 4.05 134.865
Present value 2.43 3.29 98.61
sum of present values 104.33
The stocks current price is equal to $104.33.

jeff jeffy answered 1 year ago
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