Question

A company, GameMore, has just paid a dividend of $2 per share, D₀=$ 2 . It is estimated that the company's dividend will grow at a rate of 15% percent per year for the next 2 years, then the dividend will grow at a constant rate of 6% thereafter. The company's stock has a beta equal to 1.4, the risk-free rate is 4.5 percent, and the market risk premium is 4 percent. What is your estimate of the stock's current price? Round your answer to two decimal places.

Answer 1

Recent Dividend, D0 = $2.00

Growth rate for next two years is 15%, followed by a constant growth rate (g) of 6%

D1 = $2.0000 * 1.15 = $2.3000
D2 = $2.3000 * 1.15 = $2.6450
D3 = $2.6450 * 1.06 = $2.8037

Required Return, rs = Risk-free Rate + Beta * Market Risk Premium
Required Return, rs = 4.5% + 1.4 * 4%
Required Return, rs = 10.1%

P2 = D3 / (rs - g)
P2 = $2.8037 / (0.101 - 0.06)
P2 = $68.3829

P0 = $2.30/1.101 + $2.645/1.101^2 + $68.3829/1.101^2
P0 = $60.68

So, current price of stock is $60.68