Question

Red Sun Rising just paid a dividend of $2.49 per share. The company said that it will increase the dividend by 25 percent and 20 over the next two years, respectively. After that, the company is expected to increase its annual dividend at 3.9 percent. If the required return is 11.7 percent, what is the stock price today

Answer 1

Step 1: Computation of market price at the end of year 2 using Gordon Growth Mdel

P2 = D3 / (Ke – g)

Where,

P2 – share price in year 2 = ?

D3 – expected dividend in year 3 = 2.49*1.25*1.2*1.039 = 3.880665

Ke – Cost of equity = 11.7%

G – Growth rate in dividend = 3.9%

P2 = 3.880665/(.117-.039)

= 3.880665/0.078

= 49.75

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	[email protected]%	Present Value (Cashflow*PVF)
1	3.11(2.49*1.25)	0.895	2.79
2	53.49(3.11*1.2+49.75)	0.801	42.87

current share price = Present Value

= 2.79+42.87

= $45.66

You can use the equation 1/(1+i)^n to find PVF using calculator