Question

A company currently pays a dividend of $3.5 per share. It is estimated that the company’s dividend will grow at a rate of 22% per year for the next 2 years, then at a constant rate of 7.5% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 8.5%, and the market risk premium is 4.5%. What is your estimate of the stock’s current price?

Answer 1

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Answer:

Required return=Risk free rate+Beta*Market risk Premium

=8.5+(1.2*4.5)=13.9%

D1=(3.5*1.22)=4.27

D2=(4.27*1.22)=$5.2094

Value after year 2=(D2*Growth rate)/(Required return-Growth rate)

=(5.2094*1.075)/(0.139-0.075)=$87.50164

Hence current price=Future dividends*Present value of discounting factor(16.7%,time period)

=4.27/1.139+5.2094/1.139^2+87.50164/1.139^2

which is equal to

=$75.21(Approx).