Question

Microsoft had experience abnormal growth. The company anticipates that it will grow at an abnormal rate of 20% for the next three years. after that. the growth rate will drop to match the industry's constant growth rate of 6%. If investors require 20% return and the firms dividend per share is expected to be $3 (DIV₁ = $3) what should be Microsofts's stock price?

Answer 1

Given about Microsoft Stock,

Expected dividend D1 = $3

growth rate for next 3 years = 20%

So, Dividend in year 2, D2 = 3*1.2 = $3.6

Dividend in year 3, D3 = 3.6*1.2 = $4.32

Dividend in year 4, D4 = 4.32*1.2 = $5.184

thereafter growth rate g = 6%

required rate of return r = 20%

So, Stock price at year 4 using constant dividend growth rate is

P4 = D4*(1+g)/(r-g) = 5.184*1.06/(0.2-0.06) = $39.25

So, stock price today is

P0 = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + D4/(1+r)^4 + P4/(1+r)^4

=> P0 = 3/1.2 + 3.6/1.2^2 + 4.32/1.2^3 + 5.184/1.2^4 + 39.25/1.2^4 = $28.93

So, Microsofts' stock price should be $28.93