Question

A stock will pay dividends of $1, $5, and $10 over the next three years, and then increase dividends at a rate of 2% afterwards. Its required rate of return is 19%. What is the value of the stock? Round to the penny.

Answer 1

Stock price at the end of Year 3 = (Dividend in year 3)*(1+growth rate)/(Required rate of return - Growth rate)
=(10)*(1+2%)/(19% - 2%)
=10.2/0.17
=60
Now, we need to discount the cash flows to present value using the discount rate of 19%.

Value of the stock=1/(1+19%)^1+5/(1+19%)^2+10/(1+19%)^3+60/(1+19%)^3
=1/(1.19)^1+5/(1.19)^2+10/(1.19)^3+60/(1.19)^3
=1/1.19+5/1.4161+10/1.685159+60/1.685159
=0.840336134+3.530824094+5.934158142+35.60494885
=45.91026722 or 45.91 (Rounded to the penny)

Answer: Hence, the value of the stock is $45.91