Question

General Dynamics Industries just paid a dividend of D₀= $3.75. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock’s current market value?

a.              $144.04

b.              $135.11

c.              $127.47

d.              $151.68

e.              $130.01

Answer 1

Step 1: Computation of market price at the end of year 2 using Gordon Growth Model

P2 = D3 / (Ke – g)

Where,

P2 - Market price at the end of year 2 =?

D3 - Expected dividend in year 3 = 3.75*1.3*1.1*1.05 = 5.630625

Ke – Cost of equity = 9%

G – Growth rate in dividend = 5%

P2 = 5.630625/(.09-.05)

= 5.630625/.04

= $140.77

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@9%	Present Value (Cashflow*PVF)
1	4.8750(3.75*1.3)	0.917	4.47
2	146.1325(4.875*1.1+140.77)	0.842	123.00

current share price = Cashflow*PVF

= 4.47+123

= $127.47

You can use the equation 1/(1+i)^n to find PVF using calculator