Question

Magnetic Corporation expects dividends to grow at a rate of 14.7% for the next two years. After two years dividends are expected to grow at a constant rate of 3.8%, indefinitely. Magnetic’s required rate of return is 14.6% and they paid a $1.43 dividend today. What is the value of Magnetic Corporation’s common stock per share? (Show your answers to the nearest cent)

Dividend at end of year 1:

Dividend at end of year 2:

Dividend at end of year 3:

Price of stock at end of year 2:

Price of stock today:

Answer 1

Required return on share = 14.60%

Dividend at end of year 1: D₀ x (1+growth rate) = $1.43 x (1+14.7%) = $ 1.64

Dividend at end of year 2: D₁ x (1+growth rate) = $1.64 x (1+14.7%) = $ 1.88

Dividend at end of year 3: D₂ x (1+growth rate) = $1.88 x (1+3.8%) = $ 1.95

Using Gordon's dividend growth model,

Price of stock at end of year 2: D₃ / (ke-g) = 1.95 / (14.60 - 3.80%) = $18.06

Price of stock today: Price of stock at end of year 2 / (1+ke)² = $ 18.06 / (1+14.60%)² = $13.75

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