Question

Harry Harrison wishes to purchase the common stock of the Hudson Hairpin Corp. The company is projecting that they will pay annual dividends in the amount of $2.00, $2.50, $3.00, $3.50, and $4.00 over the next five years, respectively. Harry expects that he will be able to sell the stock at the end of the fifth year for $65.00. If his required rate of return is 18.25%, what will he pay for the stock today ?

Answer 1

Dividend Growth model also called as Gordon's Growth model is used to determine the intrinsic value of stock based on future dividends assuming company grows at constant rate.

Calculation of Value of Stock today

Year	Dividends	Present Value factor @18.25%	Present Value of Dividends
1	$2.00	0.8457	1.6914
2	$2.50	0.7152	1.788
3	$3.00	0.6048	1.8144
4	$3.50	0.5114	1.7899
5	$4.00	0.4325	1.73
			8.8137

Present Value of Stock Price at the end of 5th year = Stock Price at end of 5th yr * Present value factor of 5th year
= $65.00 * 0.4325
= $28.1125

Value of stock today = Present value of dividends + Present value of stock price of 5th year
= $8.8137 + $28.1125
= $36.9262
= ~$36.93

Ans : Harry will pay $36.93 for the stock today