Question

Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. Your company is about as risky as the average firm in the industry and just paid a dividend (D₀) of $2. You expect that the growth rate of dividends will be 50% during the first year (g_0,1 = 50%) and 30% during the second year (g_1,2 = 30%). After Year 2, dividend growth will be constant at 4%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Step 1 )Required return on stock =Dividend Yield +Growth

                                             = 6 +4

                                             = 10%

Step 2)

Year	Dividend	Present value at 10%	Dividend *Present value
1	2(1+.50) = 3	.90909	2.73
2	3(1+.30)= 3.90	.82645	3.22
Terminal value /Horizon value at year 2	67.60	.82645	55.87
estimated value per share of your firm’s stock			61.82

working :

Terminal value at year 2 =D2(1+g)/(Rs-g)

                   = 3.90(1+.04)/(.10-.04)

                   = 3.90*1.04/.06

                   = 67.60

**Fins present value factor from table at 10% or using the formula :1/(1+i)^n