Question

The dividend for Should I, Inc., is currently $1.20 per share. It is expected to grow at 20 percent next year and then decline linearly to a perpetual rate of 5 percent beginning in four years. If you required a return of 16 percent on the stock, what is the most you would pay per share? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Growth year 1 = 20%, Growth 2 = 15%, Growth 3 = 10%, Growth 4 = 5%
D1 = 1.20*(1+growth rate) = 1.20*1.2 = 1.44
D2 = 1.44*(1+growth) = 1.44*(1+15%) = 1.656
D3 = 1.656*(1+Growth) = 1.656*(1+10%) = 1.8216
D4 =   1.8216 *(1+growth) = 1.8216*(1+5%) = 1.92168
Terminal Value = D4/(R-g) = 1.92168/(20%-5%) = 17.388



PV or Price of Share = 1.44/(1+16%)¹ + 1.656/(1+16%)² + 1.8216/(1+16%)³ +17.388/(1+16%)³ = 14.78

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