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Stock Z is expected to pay a dividend of $3 on one year, $8 in two...

Stock Z is expected to pay a dividend of $3 on one year, $8 in two years and subsequently one expects dividends to grow at a rate of 4%. If the required rate of return on the stock is 10%, what is the current stock price?

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Answer #1

Next year dividend = D1 = $3, Dividend in two years = D2 = 8

Growth rate of dividends after 2 years = g = 4%

Required return of stock = r = 10%

Since dividends are expected to grow at 4% after year 2 , so we will use constant growth rate model to calculate the terminal value of stock at the end of 2 years

Let T be the terminal value of stock at the end of 2 years

T = 8.32 / 6% = 138.67

Now Let Current price of stock = P

P = 2.72 + 121.21 = 123.93

Therefore current price of stock = $123.93

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