Question

The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is expected to be constant at 30% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (r_s) is 11%, what is its current stock price?

Select the correct answer.

a. $54.43

b. $56.59

c. $57.31

d. $55.15

e. $55.87

Answer 1

Answer :

First, calculate the dividends from year 1 to year 3

Here, D0,D1,D2,D3 are the dividends in year 0 ( last dividend paid ), year 1, year 2 and year 3

D1 = D0 * ( 1 + Growth rate )

= $1.25 * ( 1 + 30% )

= $1.625

D2 = D1 * ( 1 + Growth rate )

= $1.625 * ( 1 + 30% )

= $2.1125

D3 = D2 * ( 1 + Growth rate )

= $2.1125 * ( 1 + 30% )

= $2.74625

Now, calculate the terminal value in year 3 ( as the cash flow increase by 6% forever after year 3 )

Terminal value = D3 * ( 1 + Growth rate ) / ( Required rate - Growth rate )

= $2.74625 * ( 1 + 6% ) / ( 11% - 6% )

= $58.2205

finally, Calculate the current stock price.

Current price = D1 / ( 1 + rate)^1 + D2 / ( 1 + rate )^2 + D3 + Terminal value / ( 1 + rate )^3

= $1.625 / ( 1 + 11% )^1 + $2.1125 / ( 1 + 11% )^2 + $2.74625 + $58.2205 / ( 1 + 11% )^3

= $1.46 + $1.71 + $44.58

= $47.75.