Question

Consider a stock that will have dividend growth rates in the next three periods of 15%, 16%, and 4.5%, respectively. The third growth rate remains forever. The company just paid a dividend, D_0, of $1.475. The interest rate is 12%.

a) How much are the dividends in periods 1, 2, and 3? Enter your answers rounded to 2 DECIMAL PLACES.

b) Using 2.06 as the dividend in period 3, what is the price of the stock at time 2?

Answer 1

- Dividend just paid(D0) =$1.475

Dividend growth rates in the next three periods of 15%, 16%, and 4.5%, respectively

a). Dividend in year1(D1) = D0(1+ Year 1 growth rate) = $1.475*(1+0.15)

Dividend in year1 = $1.69625

- Dividend in year 2(D2) = D1(1+ Year 2 growth rate) = $1.69625*(1+0.16)

Dividend in year 2 = $1.96765

- Dividend in year 3(D3) = D2(1+ Year 3 growth rate) = $1.96765*(1+0.045)

Dividend in year3 = $2.05619

b). Calculating the Price of stock at time 2:-

where, D3 = Dividend in year3 = $2.05619

ke = Interest rate = 12%

g = growth rate of dividend in and after 3 year forever = 4.5%

P2 = $27.42

So, the price of the stock at time 2 is $27.42

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