Question

After thorough research you can clued that Gore Inc.’s Dividend will grow edit present rate of 10% for two more years. After the payment payment in year 2, The growth rate in dividends will drop to 3% permanently the last dividend which you just paid was $1.50. If the required rate of return is 8% what is the current value of the stock

1. $36.64
2. $34.15
3. $37.95
4. $35.14
5. None of the above are correct

Answer 1

Given the Following

Last Dividedn Paid D0 = 1.50

Rate of Return (Re) = 8%

It is given that the dividends would continue to grow @ 10% for 2 years, thereafter it would continue to grow at a constant rate of 3%.

Therefore the Value of Share Using Dividedn Disocount Model = Present Value of all the dividends of the share.

At Year 3 when the Dividend Grows at a constant Growth rate of 3%, we can compute the horizon value using the below formula = D3/(Re-G) where G is the Constant Growth Rate, and D3 = Dividend at the end of Year 3

Now Value of Share = D1/ (1+Re) + D2/ (1+Re)^2 + Terminal Value or Horizon Value / (1+ Re)^2

Therefore

D1 = D0 *(1+G), where G = 10%

D1 = 1.50 * (1.10) = D1 = $ 1.65

D2 = D1 *(1+G) , where G = 10%

D2 = 1.65 *(1.10) = D2 = $ 1.815

Now D3 = D2 *(1+G) , where G = 3%

D3 = 1.815 * (1.03) = $ 1.86945

Now Terminal Value or Horizon Value at the end of Year 2 = $ 1.86945/ (8-3)% = $ 37.389

Therefore The value of Share = 1.65 /(1.08) +  1.815/(1.08)^2 + 37.389/(1.08)^2

Value of Share = $ 35.14

Therefore Correct Answer is D