Question

A company has a 15.50% required rate of return and will not pay any dividends for the next seven years. At the beginning of year 8, it will pay a dividend of $4.75 per share. The dividend (always paid at the beginning of a year) is expected to grow at 9.75% annually from that point onwards. Calculate the stock price today.

Answer 1

given about a company,

Required rate of return r = 15.50%

company will not pay dividend for next 7 years.

dividend at the beginning of year 8 is same as dividend at the end of year 7,

So, Dividend at the end of year 7 D7 = $4.75

dividend's expected growth rate g = 9.75%

So, price of stock at the end of year 6 using constant dividend model is

P6 = D7/(r - g) = 4.75/(0.1550-0.0975) = $82.61

So, stock price today is present value of price at year 6 discounted at r

=> P0 = P6/(1+r)^6 = 82.61/(1 + 0.155)^6 = $34.80

So, stock price today is $34.80