Question

Ackert Company's last dividend was $0.50. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (r) is 12.0%. What is the best estimate of the current stock price?

Answer 1

The price is computed as shown below:

= Dividend in year 1 / ( 1 + required rate of return)¹ + Dividend in year 2 / ( 1 + required rate of return)² + 1 / ( 1 + required rate of return)² [ ( Dividend in year 2 (1 + growth rate) / ( required rate of return - growth rate) ]

= ($ 0.50 x 1.015) / 1.12 + ($ 0.50 x 1.015²) / 1.12² + 1 / 1.12² x [ ($ 0.50 x 1.015² x 1.08) / (0.12 - 0.08) ]  

= $ 0.5075 / 1.12 + $ 0.5151125 / 1.12² + 1 / 1.12² x [ ($ 13.9080375) ]

= $ 0.5075 / 1.12 + $ 14.42315 / 1.12²

= $ 11.95 Approximately

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