Question

The Ramirez Company's last dividend was $1.75. Its dividend growth rate is expected to be constant at 24% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (r_S) is 12%. What is the best estimate of the current stock price? Do not round intermediate calculations.

a. $36.94

b. $52.47

c. $45.34

d. $41.98

e. $31.90

Answer 1

d. $41.98

According to the dividend discount model, the current stock price is the present value of all the future dividends

First, we calculate the terminal value in year 2nd year and then discount all the dividends to present value

Terminal value in year 2 = Dividend in year 3/(r-g)

r = required return

g = perpetual growth rate

Terminal value in year 2 = 1.75*1.24*1.24*1.06/(0.12-0.06)

Terminal value in year 2 = 47.537

Current stock price = (1.75*1.24/(1.12)) + (1.75*1.24*1.24/(1.12^2)) + (47.537/(1.12^2))

Current stock price = 41.98