Question

Show all your work (use of formula, etc.) in solving the problems. You still need to show your work even if you use the financial calculator to get the answers. Thank you!

5. Rizzi Co. is growing quickly. The company just paid a $1.6 per share dividend and dividends are expected to grow at a 25%, 15% and 10% rate respectively for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 11 percent, what is the current share price?

Answer 1

The formula of calculating current share price is:

P₀ = D1/(1+r)¹ +  D2/(1+r)²  + D3/(1+r)³+  (D4/(r-g_c))(1+r)^-3

^{Here, P}0 is stock price at time 0

D is the expected dividend

r is required rate of return

g_c is the constant growth rate

Now, calculate the dividend value:

D₁ = 1.6(1 + .25) = $2

D₂= 2(1 + .15) = $2.3

D₃= 2.3(1 + .10) =$2.53

D₄ = 2.53(1 + .06) =$2.68

Substituting the formula we have:

P₀ =2/(1+.11)¹ + 2.3/(1+.11)² +2.53/(1+.11)³ +(2.68/(.11-.06))(1+.11)^-3

^{=1.802 + 1.867 + 1.850 + 39.192}

^{= $44.711}

^{Thus, current share price is $44.711}