Question

Microsoft has just paid a dividend of $1 per share (this dividend is already paid sometimes called Dividend 0). It is estimated that the companys dividend will grow at a rate of 35% in year 1 and 20% in year 2.  The dividend is then expected to grow at a constant rate of 7% thereafter.  The companys opportunity cost of capital is 11% what is an estimate Microsofts stock using the nonconstant growth technique?

Answer 1

To calculate price of stock we require to first calculate the dividend of Year 1 and Year 2 and terminal value or say price of share at the end of Year 2 using gordon growth model and find the present value of all future value i.e. current price of stock.

D0 = $1

D1 = $1 x (1+g) = $1 x (1+0.35) = $1.35

D2 = $1.35 x (1+g) = $1.35 x (1+0.20) = $1.62

Terminal Value or say price of share at the end of year -2

= D3 / (ke - g) (D3 = D2 x (1+g) = $1.62 x (1+0.07) = $1.7334

= $1.7334 / (0.11 - 0.07)

= $1.7334 / 0.04

= $43.335

Now we find out the present value of future cashflow

Year	Dividend	DF @ 11%	PV
1	$1.35	0.900900901	$1.22
2	$1.62	0.811622433	$1.31
Stock Price at end of year 2	$43.335	0.731191381	$31.69
Present Value / Current Value of Stock	$34.22

Estimated value of stock price of microsoft is $34.22.