Question

Cullumber, Inc., is a fast-growing technology company. Management projects rapid growth of 30 percent for the next two years, then a growth rate of 17 percent for the following two years. After that, a constant-growth rate of 8 percent is expected. The firm expects to pay its first dividend of $2.52 a year from now. If dividends will grow at the same rate as the firm and the required rate of return on stocks with similar risk is 18 percent, what is the current value of the stock?

Answer 1

Expected Dividend, D1 = $2.52

Growth rate for next 2 months is 30%, for next 2 months is 17% and a constant growth rate (g) is 8%

D2 = $2.5200 * 1.30 = $3.2760
D3 = $3.2760 * 1.30 = $4.2588
D4 = $4.2588 * 1.17 = $4.9828
D5 = $4.9828 * 1.17 = $5.8299
D6 = $5.8299 * 1.08 = $6.2963

Required Return, rs = 18%

P5 = D6 / (rs - g)
P5 = $6.2963 / (0.18 - 0.08)
P5 = $6.2963 / 0.10
P5 = $62.9630

P0 = $2.52/1.18 + $3.276/1.18^2 + $4.2588/1.18^3 + $4.9828/1.18^4 + $5.8299/1.18^5 + $62.9630/1.18^5
P0 = $39.72

Therefore, current value of the stock is $39.72