Question

The risk-free rate is 2.59% and the market risk premium is 8.75%. A stock with a β of 1.32 just paid a dividend of $2.52. The dividend is expected to grow at 21.52% for three years and then grow at 3.06% forever. What is the value of the stock?

Answer 1

Required return=risk free rate+Beta*market risk premium

=2.59+(1.32*8.75)=14.14%

D1=(2.52*1.2152)=3.062304

D2=(3.062304*1.2152)=3.72131182

D3=(3.72131182*1.2152)=4.52213812

Value after year 3=(D3*Growth rate)/(Required return-Growth rate)

=(4.52213812*1.0306)/(0.1414-0.0306)

=42.0624147

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=3.062304/1.1414+3.72131182/1.1414^2+4.52213812/1.1414^3+42.0624147/1.1414^3

=$36.87(Approx).