Question

The dividend for Should I, Inc., is currently $1.55 per share. It is expected to grow at 16 percent next year and then decline linearly to a 4 percent perpetual rate in four years. If you require a 13 percent return on the stock, what is the most you would pay per share?

Answer 1

HI,

Here Current dividend D0 = $1.55

initial growth rate g1 = 16%

so next year dividend D1 = 1.55*(1+16%) = $1.798

D2 = 1.798*(1+12%) = $2.01

D3 = 1.798*(1+8%) = $2.15

and then perpetual growth rate g = 4%

return k = 13%

As per dividend discount model a stock price will be equal to all its future dividends till perpetuity,.

So Current share price = 1.798/(1+13%) + 2.01/(1+13%)^2 + 2.15/(1+13%)^3 + 2.15*(1+4%)/(13%-4%)(1+13%)^3

=1.59 +1.58 + 1.51 +17.42 = $22.09

Hence $22.09 is the most you will pay for the stock,

Thanks