Question

Far Side Corporation is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $17 per share 10 years from today and will increase the dividend by 3.9 percent per year thereafter. If the required return on this stock is 12.5 percent, what is the current share price?

Answer 1

Step-1, The Calculation of the share price in Year-9

Here, we have dividend per share in Year 10 (D10) = $17.00 per share

Dividend Growth Rate (g) = 3.90% per year

Required Rate of Return (Ke) = 12.50%

Therefore ,t eh Share price in Year 9 (P9) = D10 / (Ke – g)

= $17.00 / (0.1250 – 0.0390)

= $17.00 / 0.0860

= $197.67

Step-2, The Calculation of the current share price (P0)

Here, we’ve the share price in Year-9 (P9) = $197.37

The current share price is the Present value of the future cash flows

Therefore, the current share price = P9 / (1 + Ke)⁹

= $197.37 / (1 + 0.1250)⁹

= $197.37 / (1.1250)⁹

= $197.37 / 2.886507578

= $68.48 per share

“Hence, the current share price will be $68.48”