Question

Garcia Inc. has a current dividend of $3.00 per share (D0 = $3.00). Analysts expect that the dividend will grow at a rate of 25 percent a year for the next three years, and thereafter it will grow at a constant rate of 10 percent a year. The company's cost of equity capital is estimated to be 15 percent. What is the current stock price of Garcia Inc.? Select one: a. $ 95.42 b. $ 88.55 c. $103.25 d. $ 75.00 e. $110.00

Answer 1

Current Stock Price = Present Value of Dividends +  Present Value of Price at Year 3

Note:

Present Value of Dividends =$ 10.6579271800773 +$ 84.757951836936

= $ 95.42

Hence the correct answer is a. $ 95.42

Note:

Year	Dividend	Discounting Factor (15%)	Present Value ( Dividend * Discounting factor)
0	3
1	3.75	0.869565217	3.260869565217390
2	4.6875	0.756143667	3.544423440453690
3	5.859375	0.657516232	3.852634174406180
Present Value of Dividends			10.6579271800773

Price a Year 3 = Expected Dividend / ( Cost of Equity - Growth Rate)

= ($ 5.859375 * 110%) / ( 15% - 10%)

= $ 128.90625

Present Value of Price a Year 3 = Price a Year 3 * Present Value of Discounting Factor ( 15%,3)

= $ 128.90625*0.657516232

= $ 84.757951836936