Question

A company currently pays a dividend of $2.4 per share (D0 = $2.4). It is estimated that the company's dividend will grow at a rate of 24% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 3%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent. $

Answer 1

HI

Here Cost of equity of stock as per CAPM model = risk free rate + beta*market risk premium

= 7.5 + 1.2*3

=7.5 + 3.6 = 11.1%

As per DDM stock's current price will be sum of present value of future dividends.

Current Dividend D0 = $2.4

D1 = 2.4*(1+24%) = $2.976

D2 = 2.976*(1+24%) = $3.69

constant growth g = 7%

So Current stock price = 2.976/(1+11.1%) + 3.69/(1+11.1%)^2 + 3.69*(1+7%)/((1+11.1%)^2*(11.1%-7%))  

=2.68 + 2.99 +3.95/0.05

=2.68 + 2.99 + 78.02

=$ 83.69

Thanks