Question

Barden Corp. just paid a dividend of D₀ = $1.50. Analysts expect the company's dividend to grow by 30% for the next two years and at a constant rate of 5% in Year 3 and thereafter. The required return on this stock is 9.00%. What is the best estimate of the stock’s current fair value?

a. $47.09

b. $49.43

c. $54.99

d. $59.93

e. $68.45

Answer 1

Given about Barden Corp.

Last dividend D0 = $1.50

company's dividend to grow by 30% for the next two years

=> D1 = D0*1.3 = 1.5*1.3 = $1.95

D2 = D2*1.3 = 1.95*1.3 = $2.535

Thereafter growth rate g = 5%

required return on stock rs = 9%

So, stock price at year 2 using constant dividend growth rate is

P2 = D2*(1+g)/(rs-g) = 2.535*1.05/(0.09-0.05) = $66.54

So, stock price today is sum of PV of future dividends and P2 discounted at rs

=> P0 = D1/(1+rs) + D2/(1+rs)^2 + P2/(1+rs)^2 = 1.95/1.09 + 2.535/1.09^2 + 66.54/1.09^2 = $59.93

stock’s current fair value = $59.93

Option D is correct.