Question

Johnson and Johnson just paid a dividend of $1.00. And it will pay $1.50 at the end of year 1 and $2.00 at the end of year 2 as annual dividends. Then, the annual dividend will grow at 10% per year indefinietly from year 3. If the required rate of return is 18%, what is the price of the stock now?

Answer 1

Dividend in Year 1, D1 = $1.50
Dividend in Year 2, D2 = $2.00
Growth Rate, g = 10%

Dividend in Year 3, D3 = D2 * (1 + g)
Dividend in Year 3, D3 = $2.00 * 1.10
Dividend in Year 3, D3 = $2.20

Required Return, rs = 18%

Stock Price in Year 2, P2 = D3 / (rs - g)
Stock Price in Year 2, P2 = $2.20 / (0.18 - 0.10)
Stock Price in Year 2, P2 = $2.20 / 0.08
Stock Price in Year 2, P2 = $27.50

Current Stock Price, P0 = D1/(1+rs) + D2/(1+rs)^2 + P2/(1+rs)^2
Current Stock Price, P0 = $1.50/1.18 + $2.00/1.18^2 + $27.50/1.18^2
Current Stock Price, P0 = $22.46