Question

spooner corporations next dividend is expected to be $6. dividend growth is estimated at 25%, 20%, 10% and then stabilize to 3% if the rate

spooner corporations next dividend is expected to be six dollars. Dividend growth is estimated at 25%, 20%, 10% and then stabilize to 3%. If the rate of return is 10% determine the stock price next year.

Answer 1

the growth rate is given as 25% in yr1, 20% in yr2, 10% in yr 3, and 3% thereafter.

Rate of return(r) = 10%

Dividend in yr 1(D1) = 6

Dividend in yr 2(D2) = 6 * (1+g) = 6*(1+.25) = 7.5

Dividend in yr 3(D3) = 7.5 * (1+g) = 7.5*(1+.20) = 9

Dividend in yr 4(D4) = 9 * (1+g) = 9*(1+.10) = 9.9

We can calculate the price in year 4 by the Gordon's growth model formula

Price in year 4 = D4(1+g) / (r-g)

g = 3%

r = 10%

P4 = 9.9(1+.03) / (.10 - .03)

= 10.197 / .07

= $145.67

Price in year 4 is $145.67

We have to calculate the stock price in next year i.e., P1

P1 = P4 / (1+r)^3

= 145.67 / (1.1)^3

= $109.44

Hence the price next year will be $109.44

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