Question

Victoria Rob is considering purchasing the common stock of Warren Industries, a rapidly growing boat manufacturer. She finds that the firm’s most recent (2019) annual dividend payment was $1.5 per share. Victoria estimates that these dividends will increase at a 10% annual rate, g, over the next 3 years (2020, 2021, 2022) because of the introduction of a hot new boat. At the end of the 3 years (the end of 2022) she expects the firm’s mature product line to result in a slowing of the dividend growth rate to 5% per year for the foreseeable future. Victoria’s required rate of return is 15%. Estimate the value of Warren’s common stock in 2019.

Answer 1

Dividend, 2019 = $1.50

Growth rate for next 3 years is 10% and a constant growth rate of 5% thereafter

Dividend, 2020 = $1.50 * 1.10 = $1.65
Dividend, 2021 = $1.65 * 1.10 = $1.815
Dividend, 2022 = $1.815 * 1.10 = $1.9965
Dividend, 2023 = $1.9965 * 1.05 = $2.096325

Required Return = 15%

Stock Price, 2022 = Dividend, 2023 / (Required Return - Growth Rate)
Stock Price, 2022 = $2.096325 / (0.15 - 0.05)
Stock Price, 2022 = $20.96325

Stock Price, 2019 = $1.65/1.15 + $1.815/1.15^2 + $1.9965/1.15^3 + $20.96325/1.15^3
Stock Price, 2019 = $17.90