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In: Finance

A company recently paid a dividend of $1.20 per share. It is estimated that the company's...

A company recently paid a dividend of $1.20 per share. It is estimated that the company's dividend will grow at the rate of 15% per year for the next 5 years, then at a constant rate of 7% a year thereafter. The required return on this company is 8.80%. What is the estimated stock price today?

Solutions

Expert Solution

As per dividend discount model, current price of stock is the present value of future dividends.
Step-1:Calculate present value of dividend of next 5 years
Year Dividend Discount factor Present value
a b c=1.088^-a d=b*c
1 $       1.38 0.919118 $       1.27
2 $       1.59 0.844777 $       1.34
3 $       1.83 0.77645 $       1.42
4 $       2.10 0.713649 $       1.50
5 $       2.42 0.655927 $       1.58
Total $       7.11
Working:
Year Dividend
1 1.20*1.15           1.38
2 1.38*1.15           1.59
3 1.59*1.15           1.83
4 1.83*1.15           2.10
5 2.10*1.15           2.42
Step-2:Calculate present value of after year 5's dividend
Present value = Present value of future dividends at 5 years from now * Present value of 1
= (D5*(1+g)/Ke-g))*(1+Ke)^-n
= (2.42*(1+0.07)/(0.088-0.07))*(1+0.088)^-5
= $    94.36
Where,
D5 Dividend of year 5 $       2.42
g Growth rate in dividend      0.0700
Ke Required rate of return      0.0880
Step-3:Calculation of present value of all dividend
Present value of all dividends = $       7.11 + $    94.36
= $ 101.47
So, estimated stock price today is $ 101.47

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