Question

A firm named Amadeus expects to pay a dividend of €1.00 per share the next year (t=1). In year t=2, the dividend will grow 40%. The dividend at year 3 will be 3€ and it will remain constant up to infinit. If the discount rate for firms like Amadeus is 10%, compute the stock’s price of Amadeus (choose the closest price).

Select one:

a. 15.19€

b. 26.85€

c. 47.24€

d. 32.56€

e. No answer

Answer 1

The price is computed as shown below:

= Dividend in year 1 / (1 + discount rate) + Dividend in year 2 / (1 + discount rate)² + 1 / (1 + discount rate)² x [ Dividend in year 3 / (discount rate) ]

= 1 / 1.10 + ( 1 x 1.40) / 1.10² + 1 / 1.10² x [ ( 3 / 0.10) ]

= 1 / 1.10 + 1.40 / 1.10² + 1 / 1.10² x 30

= 1 / 1.10 + 31.40 / 1.10²

= 26.85 Approximately

So, the correct answer is option b.

Feel free to ask in case of any query relating to this question