Question

New Gadgets, Inc., currently pays no dividend but is expected to pay its first annual dividend...

New Gadgets, Inc., currently pays no dividend but is expected to pay its first annual dividend of $5.40 per share exactly 5 years from today. After that, the dividends are expected to grow at 3.7 percent forever. If the required return is 12.3 percent, what is the price of the stock today?

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Answer #1

Price of the stock today (P0)

The Price of the stock today is the Present Value of the Future Dividend (D5) plus the present value of the share price in year 5

Dividend per share Year 5 (D5) = $5.40 per share

Price of share in Year 5 (P5) = D5(1 + g) / (Ke – g)

= $5.40(1 + 0.0370) / (0.1230 – 0.0370)

= $5.60 / 0.0860

= $65.11 per share

Therefore, the Price of the stock today

Price of the stock (P0) = D5/(1 + r)5 + P5/(1 + r)5

= [$5.40 / (1 + 0.1230)5] + [$65.11 / (1 + 0.1230)5]

= [$5.40 / 1.78607] + [$65.11 / 1.78607]

= $3.02 + $36.46

= $39.48 per share

“Hence, the price of the stock would be $39.48 per share”

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