In: Finance
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?
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 | |||||||||