Question

Dividends are expected to grow at 30%, 25%, 20%, 15%, and 10% for the next 5 years. From the 6th year onwards a stable growth rate of 10% is expected. The current share price is $46, its most recent dividend per share was $1.75 per share and its required rate is 10%, what would you recommend to your CFO regarding what to do with the investment?

Answer 1

Now since at the end of high growth period, required return and growth rate are equal, therefore we cannot calculate the value of the stock as the denominator shall be zero. So other methods would be used to value the stock. This is not possible now due to lack of other information.

Now since we cannot value the stock using the dividend discount model, it does not mean that the stock is not worth. The stock is very valuable since it provides a growth rate that is equal to required return. The recommendation to the CFO shall be to reinvest the maximum possible amount into the company to get an additional value.