Question

Brickhouse is expected to pay a dividend of $3.05 and $2.42 over the next two years, respectively. After that, the company is expected to increase its annual dividend at 3.7 percent. What is the stock price today if the required return is 11.1 percent?

Answer 1

Required return on share = 11.1%

Dividend at end of year 1 (D₁) = $ 3.05

Dividend at end of year 2 (D₂) = $ 2.42

Dividend at end of year 3 (D₃) = D₂ x (1+growth rate) = $2.42 x (1+3.7%) = $ 2.51

Using Gordon's dividend growth model,

Price of stock at end of year 2 (P₂): D₃ / (ke-g) = 2.51 / (11.1% - 3.7%) = $ 33.92

Price of stock today = D₁ / 1+Ke + (D₂ + P₂) / (1+ke)² = 3.05 / (1 + 11.1%) + (2.42+33.92) / (1+11.1%)² = $ 32.19

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