Question

A company currently pays a dividend of $2 per share (D₀ = $2). It is estimated that the company's dividend will grow at a rate of 16% per year for the next 2 years, and then at a constant rate of 8% thereafter. The company's stock has a beta of 1.4, the risk-free rate is 7.5%, and the market risk premium is 3.5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.c

Answer 1

Solution:
	Expected rate of return or Cost of equity:	Risk free return + Beta (Market Risk Premium)
	Expected rate of return or Cost of equity:	0.075 + 1.4 * 0.035
	Expected rate of return or Cost of equity:	0.124	or 12.4%
	D0 = $ 2	& Growth for 2 year is 16%
	Hence, D1 = $2(1.16)= $ 2.32 & D2 = $2(1.16)^2 = $2.70
	Current Stock Price after 2 year :	Dividend (1+ Growth Rate) / (Cost of Capital - Growth Rate)
	Current Stock Price after 2 year :	2.70 (1+ 0.08) / (0.124 - 0.08)
	Current Stock Price after 2 year :	2.916 / 0.044
	Current Stock Price after 2 year :	$ 66.27
	Hence, current Stock price at Y0:	Current Stock Price after 2 year / (1+Cost of equity)^2
	current Stock price at Y0:	$ 66.27 / (1.124)^2
	current Stock price at Y0:	$ 52.45

(Please provide your valuable feedback and upvote. Thank You)