Question

Question 7

A company is growing at a constant rate of 8 percent. Last week it paid a dividend of $3.00. If the required rate of return is 15 percent, what is the price of the stock three years from now?

	a.	$58.31
	b.	$55.15
	c.	$45.15
	d.	$56.21

Answer 1

Step-1, Calculation of Dividend per share for the next 3 years

Dividend in Year 0 (D0) = $3.00 per share

Dividend in Year 1 (D1) = $3.2400 per share [$3.00 x 108%]

Dividend in Year 2 (D2) = $3.4992 per share [$3.2400 x 108%]

Dividend in Year 3 (D3) = $3.7791 per share [$3.4992 x 108%]

Step-2, Calculation of Stock Price for the Year 3 (P3)

Here, we have Dividend per share in year 3 (D3) = $3.7791 per share

Dividend Growth Rate (g) = 8.00% per year

Required Rate of Return (Ke) = 15.00%

Stock Price for the Year 3 = D3(1 + g) / (Ke – g)

= $3.7791(1 + 0.08) / (0.15 – 0.08)

= $4.0815 / 0.07

= $58.31 per share

“Hence, the price of the stock three years from now will be $58.31”