Question

Problem 8-18 Supernormal Growth [LO1]

Synovec Co. is growing quickly. Dividends are expected to grow at a rate of 20 percent for the next three years, with the growth rate falling off to a constant 5 percent thereafter. If the required return is 14 percent, and the company just paid a dividend of $2.50, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Current Share Price = ?

Answer 1

STAGE 1: When the Growth rate is 20% for 1st 3 Year

Year	Dividend (Dn-1)*1.2	DF@14% (1/1.14^n)	PV (Dividend*DF)
1	3	0.877193	2.631578947
2	3.6	0.7694675	2.770083102
3	4.32	0.6749715	2.91587695
		TOTAL	8.317539

STAGE 2: When the growth rate is 5% forever,

Using the DDM formula, we know

P3 = D3(1+g) / (Re - G)

P3 is the price at year 3, D3 is the dividend of 3rd year, Re is required rate of return and G= growth

P3 = ($4.32 * 1.05)/(14%-5%)

P3 = $4.536 / 9%

P3 = $50.40

So PV at year 0 of 3rd year price = $50.40 * 0.6749715 i.e. $34.0185644

Hence Price of Share today = Stage 1 + Stage 2

Share price = $8.317539 + $34.0185644

Share price = $42.33610342 or $42.34 (round off)