Question

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 7%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $1. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 25% during the second year (g1,2 = 25%). After Year 2, dividend growth will be constant at 6%. What is the required rate of return on your company’s stock? What is the estimated value per share of your firm’s stock?

Answer 1

Required rate = dividend yield +Growth rate
		7% + 6% = 13%
D0 = 1
D1 = 1+50% = 1.50
D2 = 1.50+25% =1.875
Expected dividend for Year-3 = 1.875+6% =1.9875
Horizon value = Expected dividend of Yyear-3 / Dividend yield
		1.9875 / 7% = 28.39
Price of Stock today
Year	cashflows	PVF at 13%	Present value
1	1.5	0.884956	1.327434
2	1.875	0.783147	1.4684
2	28.39	0.783147	22.23353
Price of Stock today			25.03