Question

# Problem 8-18 Supernormal Growth [LO1] Synovec Co. is growing quickly. Dividends are expected to grow at...

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 = ?

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

 Year Dividend (Dn-1)*1.2 [email protected]% (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)

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