Question

A stock will pay no dividends for the next 3 years. Four years from now, the stock is expected to pay its first dividend in the amount of $2.1. It is expected to pay a dividend of $2.9 exactly five years from now. The dividend is expected to grow at a rate of 7% per year forever after that point. The required return on the stock is 12%. The stock's estimated price per share exactly TWO years from now, P₂ , should be $______.

Answer 1

As per dividend discount model, price of stock is the present value of future dividends.
Step-1:Calculation of present value of dividend upto five years from now i.e. dividend upto 3 years, 2 years from now:
	2 years from now		Dividend	Discount factor		Present value of dividend
	Year
	a		b	c=1.12^-a		d=b*c
	1		0	0.8929		0.00
	2		$       2.10	0.7972		$       1.67
	3		$       2.90	0.7118		$       2.06
	Total					$       3.74
Step-2:Calculation of terminal value of dividend
	Terminal value of dividend			=	D3*(1+g)/(Ke-g)				Where,
				=	2.90*(1+0.07)/(0.12-0.07)				D3	$       2.90
				=	$    62.06				g	7%
									Ke	12%
Step-3:Calculation of present value of terminal value of dividend
	Present value of terminal value			=	$    62.06	*	(1+0.12)^-3
				=	$    62.06	*	0.71178
				=	$    44.17
Step-4:Calculation of present value of all future dividends two years from now
	Present value of future dividends				=	$       3.74	+	$    44.17
					=	$    47.91
Thus,
The stock's estimated price per share exactly TWO years from now, P2 , should be								$    47.91