Question

Verona Industries just paid a dividend of $0.95. You expect the dividend to grow at 18% for the next two years, and then the dividend will grow at 6.00% for the foreseeable future. You estimate the appropriate discount rate is 12.10%. Using this information you estimate the current price for Verona is closest to:

A.

$23.83.

B.

$21.50.

C.

$29.37.

Answer 1

The price is computed as shown below:

= Dividend in year 1 / (1 + discount rate)¹ + Dividend in year 2 / (1 + discount rate)² + 1 / (1 + discount rate)² [ (Dividend in year 2 (1 + growth rate) / (discount rate - growth rate) ]

= ($ 0.95 x 1.18) / 1.1210¹ + ($ 0.95 x 1.18²) / 1.1210² + 1 / 1.1210² [ ($ 0.95 x 1.18² x 1.06) / (0.1210 - 0.06) ]

= $ 1.121 / 1.1210 + $ 1.32278 / 1.1210² + 1 / 1.1210² [ $ 22.98601311 ]

= $ 1.121 / 1.1210 + $ 24.30879311 / 1.1210²

= $ 20.34 Approximately

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