Question

You’ve collected the following information from your favorite financial website. 52-Week Price Stock (Div) Div Yld % PE Ratio Close Price Net Chg Hi Lo 77.40 10.43 Palm Coal .36 2.6 6 13.90 –.24 55.81 33.42 Lake Lead Grp 1.54 3.8 10 40.43 –.01 131.05 70.10 SIR 2.60 2.9 10 89.09 3.07 50.24 13.95 DR Dime .80 5.2 6 15.43 –.26 35.00 20.74 Candy Galore .32 1.5 28 ?? .18 According to your research, the growth rate in dividends for SIR for the next five years is expected to be 19.5 percent. Suppose SIR meets this growth rate in dividends for the next five years and then the dividend growth rate falls to 5 percent indefinitely. Assume investors require a return of 13 percent on SIR stock. According to the dividend growth model, what should the stock price be today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current stock price $

Answer 1

The stock price today can be calculated with the use of following formula:

Stock Price Today = Dividend Year 1/(1+Required Return)^1 + Dividend Year 2/(1+Required Return)^2 + Dividend Year 3/(1+Required Return)^3 + Dividend Year 4/(1+Required Return)^4 + Dividend Year 5/(1+Required Return)^5 + Dividend Year 5*(1+Growth Rate from Year 5 Onwards)/((1+Required Return)^5*(Required Return - Growth Rate from Year 5 Onwards))

_____

Using the values provided in the question in the above formula, we get,

Stock Price Today = 2.60*(1+19.5%)/(1+13%)^1 + 2.60*(1+19.5%)^2/(1+13%)^2 + 2.60*(1+19.5%)^3/(1+13%)^3 + 2.60*(1+19.5%)^4/(1+13%)^4 + 2.60*(1+19.5%)^5/(1+13%)^5 + 2.60*(1+19.5%)^5*(1+5%)/((1+13%)^5*(13%-5%)) = $60.56 (answer)