Question

Nonconstant Growth Valuation

A company currently pays a dividend of $1.5 per share (D0 = $1.5). It is estimated that the company's dividend will grow at a rate of 19% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company's stock has a beta of 1.95, the risk-free rate is 7.5%, and the market risk premium is 3%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 7.5 + 1.95 * (3)

Expected return% = 13.35

	Required rate=	13.35%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	1.5	19.00%	1.785		1.785	1.1335	1.5748
2	1.785	19.00%	2.12415	26.711	28.83515	1.28482225	22.44291
	Long term growth rate (given)=	5.00%			Value of Stock =	Sum of discounted value =	24.02

Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 2 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor