Question

Nonconstant Growth Stock Valuation Assume that the average firm in your company's industry is expected to...

Nonconstant Growth Stock Valuation Assume that the average firm in your company's industry is expected to grow at a constant rate of 6% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $1.75. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 30% during the second year (g1,2 = 30%). After Year 2, dividend growth will be constant at 6%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Homework Answers

Answer #1

Required Rate of Return, r = Constant Growth Rate + Dividend Yield
Required Rate of Return, r = 6% + 8%
Required Rate of Return, r = 14%

D0 = $1.75
Growth rate for first year, g0,1 = 50%
Growth rate for second year, g1,2 = 30%
Constant growth rate, g = 6%

D1 = $1.7500 * 1.50 = $2.6250
D2 = $2.6250 * 1.30 = $3.4125
D3 = $3.4125 * 1.06 = $3.6173

P2 = D3 / (r - g)
P2 = $3.6173 / (0.14 - 0.06)
P2 = $45.2156

P0 = $2.625/1.14 + $3.4125/1.14^2 + $45.2156/1.14^2
P0 = $39.72

So, value per share is $39.72

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