Question

Assume that the average firm in your company's industry is expected to grow at a constant rate of 6% and that its dividend yield is 7%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $2.5. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 25% during the second year (g1,2 = 25%). After Year 2, dividend growth will be constant at 6%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Required Return, rs = Growth Rate + Dividend Yield
Required Return, rs = 6.00% + 7.00%
Required Return, rs = 13.00%

Current Dividend, D0 = $2.50

Growth rate for first year is 50%, for second year is 25% and a constant growth rate (g) of 6% thereafter

D1 = $2.5000 * 1.50 = $3.7500
D2 = $3.7500 * 1.25 = $4.6875
D3 = $4.6875 * 1.06 = $4.96875

P2 = D3 / (rs - g)
P2 = $4.96875 / (0.13 - 0.06)
P2 = $4.96875 / 0.07
P2 = $70.98214

P0 = $3.75/1.13 + $4.6875/1.13^2 + $70.98214/1.13^2
P0 = $62.58

Therefore, estimated value per share is $62.58