Question

Digicon Incorporated paid a dividend of $2.00 last year (D0 = $2.00), has a required rate of return of 20%, expects to have a growth rate of 50 percent for the next year, and thereafter the growth rate is expected to revert back to a traditional 5%. What is a share of Digicon stock worth today?

a. $20.83

b. $22.00

c. $20.00

d. $17.78

e. $18.33

Answer 1

Option C is correct

g1 = growth rate = 50%

g2 = growth rate = 5%

r = required return = 20%

Current Dividend = D0 = $2.00

Dividend in Year 1 = D1 = D0*(1+g1) = $2.00 * (1+50%) = $3.00

Dividend in Year 2 = D2 = D1*(1+g2) = $3.00 * (1+5%) = $3.15

Horizon Value = D2 /(r - g2)

= $3.15 / (20%-5%)

= $21

Digicon Stock Worth today = [D1 / (1+r)^1] + [Horizon Value / (1+r)^1]

= [$3.00 / (1+20%)^1] + [$21 / (1+20%)^1]

= [$3.00 / 1.20] + [$21 / 1.20]

= $2.5 + $17.5

= $20

Therefore, share of Digicon worth today is $20