Question

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.

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