Question

28. The company is expected to grow at 30% for the next 2 years. Beginning in the year 4, the growth rate = 7% and stabilize. The required return = 13%. The dividend in year 1 = $3.00. Calculate the stock price of this company. (D1=3, D2=2*(1+30%), D3=D2*(1+30%), D4=D3*(1+7%)…)

A) $71.88.

B) $64.68.

C) $73.01.

D) $45.41.

Answer 1

Given for a company,

Dividend in year 1 D1 = $3

growth rate for next 2 year = 30%

So, D2 = 3*1.3 = $3.9

D3 = 3.9*1.3 = $5.07

thereafter growth rate g = 7%

So, D4 = D3*1.07 = 5.07*1.07 = $5.4249

required return rs = 13%

Using constant dividend growth rate model, price of stock at year 3 is

P3 = D4/(ra-g) = 5.4249/(0.13-0.07) = $90.415

So, stock price today is sum of PV of dividend and P3 discounted at rs

So, P0 = D1/(1+rs) + D2/(1+rs)^2 + D3/(1+rs)^3 + P3/(1+rs)^3

P0 = 3/1.13 + 3.9/1.13^2 + 5.07/1.13^3 + 90.415/1.13^3 = $71.88

So, Stock price today is $71.88

Option A is correct.