Question

3. Grizzlies Inc. expects to pay $3.00 dividend on its common stock at the end of the year. The dividend is expected to grow 25% a year for the first two years, after which the dividend is expected to grow at a constant rate of 5% a year indefinitely. The stock’s beta is 1.2, the risk-free rate of interest is 6%, and the rate of return on the market portfolio is 11%. What is the company’s current stock price?

Answer 1

Answer:

Required rate of return = Risk free rate + Beta * (Market rate of return - Risk free rate)

= 6% + 1.2 * (11% - 6%)

= 12%

Expected dividend payment at the end of the year = $3

Dividend growth first two years = 25%

Thereafter dividend grows at constant rate = 5%

Stock price at the end year 3 = Dividend in year 4 / (Required return - Constant growth rate)  = 3 * (1 + 25%) ² * (1 + 5%) / (12% - 5%) = $70.3125

Current stock price = 3 / (1 + 12%) + 3 * (1 + 25%) / (1 + 12%) ² + 3 * (1 + 25%) ² / (1 + 12%) ³ + 70.3125 / (1 + 12%) ³

= $59.05

Current stock price = $59.05