Question

Beachmaster Suntan Oil’s dividend is expected to grow at a 20% rate each of the next 2 years. After that, dividend growth is expected to normalize at about 6.5% annually. Beachmaster just paid a $1.25 annual dividend per share. The require rate of the return of the stock is 12%. What is your estimated stock price today?

Answer 1

Step-1, Dividend for the next 2 years

Dividend in Year 1 (D1) = $1.50 per share [$1.25 x 120%]

Dividend in Year 2 (D2) = $1.80 per share [$1.50 x 120%]

Step-2, The Price of the stock in year 2 (P2)

Dividend Growth Rate after 2 years (g) = 6.50% per year

Required Rate of Return (Ke) = 12%

Therefore, the Share Price in year 2(P2) = D2(1 + g) / (Ke – g)

= $1.80(1 + 0.0650) / (0.12 – 0.0650)

= $1.9170 / 0.0550

= $34.85 per share

Step-3, Price of the stock today

As per Dividend Discount Model, The Current Price per share is the aggregate of the Present Value of the future dividend payments and the present value the share price in year 2

Year	Cash flow ($)	Present Value factor at 12%	Present Value of cash flows ($)
1	1.50	0.89286	1.34
2	1.80	0.79719	1.43
2	34.85	0.79719	27.79
TOTAL			30.56

“Therefore, the estimated stock price today will be $30.56 per share”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.