Question

The risk-free rate is 3.32% and the market risk premium is 7.42%. A stock with a β of 1.18 just paid a dividend of $2.18. The dividend is expected to grow at 20.43% for three years and then grow at 4.99% forever. What is the value of the stock?

Answer 1

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

=3.32+(7.42*1.18)=12.0756%

D1=(2.18*1.2043)=2.625374

D2=(2.625374*1.2043)=3.16173791

D3=(3.16173791*1.2043)=3.80768097

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

=(3.80768097*1.0499)/(0.120756-0.0499)

=56.419841

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

=2.625374/1.120756+3.16173791/1.120756^2+3.80768097/1.120756^3+56.419841/1.120756^3

=$47.64(Approx).