Question

Financial management

Please show all the calculations in detail to get the solution

Acme company just paid a dividend of $3 per share. It is expected to grow at 20% for the next 2 years and then at 4% thereafter. The required rate of return is 6%. What is the price of Acme stock?

Answer 1

present value factor = 1/(1+r)^n

year	cash flow	present value factor	cash flow * present value factor
1	$3+20%=>$3.60	1/(1.20)^1=>0.8333	(3.60)*0.8333=>$2.99988
2	$3.60+20%=>$4.32	1/(1.20)^2=>0.6944	4.32*0.6944=>2.99981
2	(see note)$224.64	1/(1.20)^2=>0.6944	224.64*0.6944=>155.99
		value of the stock	$162.00

note:

horizon value at end of year 2 = year 2 dividend *(1+growth rate) / (required return- growth rate)

=>4.32*(1.04) / (0.06-0.04)

=>4.4928/0.02

=>$224.64