Question

the rapid growth company is expected t pay a dividend of 1.00 at the end of this year. thereafter, the dividends are expected to grow at the rate of 25% per year for 2 years, and then drop to 18% for 1 year, before settling at the industry average growth rate of 10%.

if you require a return of 16% to invest in a stock of this risk level, how much would you be justified in paying for this stock?
Answer: 22.43

What's the easiest and shortest way to solve this non-constant dividend?

Answer 1

This problem can be solved by using the dividend discount model in which we calculate the present value of all the future dividend by discounting it by required rate of return.

First we calculate the terminal value of the perpetual cash-flows at year 4

Terminal value at year-4 = Dividend at year 5 / (Required rate of return - Perpetual growth rate)

Terminal value at year-4 =

We must also discount the terminal value at year-4 to Present value

The current value of the stock is therefore,

= 0.862069+0.928954+1.001028+1.018287+18.66859

= $22.47