Question

A company plans to pay no dividends in the next 3 years because it needs earnings to finance new investment projects. The firm will pay a $3.00 per share dividend in year 4 and will increase the dividend by 20% per year for the next 3 years (i.e., year 5 to year 7). After that the company will maintain a constant dividend growth rate of 6 percent per year forever. The required return on the stock is 16% per year. Assume that dividends are paid annually. Find the current stock price.

Answer 1

- Dividend paid in 4th year = $3.00

Growth rate of Dividend in next 3 years (g) = 20%

Growth rate thereafter(g1) = 6% per year forever

Required rate of Return (ke) = 165 per year

Calculating the Stock price at year end 3(P3):-

P3 = 2.5862 + $2.6754 + 2.7676 + 2.8631 + 30.3486

P3 = $41.24

Price at the end of year 3 is $41.24

Now, Calculating the Price today:-

P0 = P3/(1+ke)^3

P0 = $41.24/(1+0.16)^3

= $26.42

So, the current price is $26.42