Question

A company currently pays a dividend of $1.2 per share (D₀ = $1.2). It is estimated that the company's dividend will grow at a rate of 21% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.1, the risk-free rate is 9%, and the market risk premium is 6%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Required Return, rs = Risk-free Rate + Beta * Market Risk Premium
Required Return, rs = 9.00% + 1.10 * 6.00%
Required Return, rs = 15.60%

Last Dividend, D0 = $1.20

Growth rate for next 2 years is 21% and a constant growth rate (g) of 7% thereafter

D1 = $1.2000 * 1.21 = $1.4520
D2 = $1.4520 * 1.21 = $1.7569
D3 = $1.7569 * 1.07 = $1.8799

P2 = D3 / (rs - g)
P2 = $1.8799 / (0.156 - 0.07)
P2 = $1.8799 / 0.086
P2 = $21.8593

P0 = $1.452/1.156 + $1.7569/1.156^2 + $21.8593/1.156^2
P0 = $18.93

Therefore, current stock price is $18.93