Question

The risk-free rate is 1.99% and the market risk premium is 8.35%. A stock with a β of 1.76 just paid a dividend of $2.34. The dividend is expected to grow at 21.03% for three years and then grow at 4.09% forever. What is the value of the stock?

Answer 1

Required return=Risk free rate+beta*market risk premium

=1.99+(8.35*1.76)=16.686%

D1=(2.34*1.2103)=2.832102

D2=(2.832102*1.2103)=3.427693051

D3=(3.427693051*1.2103)=4.1485369

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

=(4.1485369*1.0409)/(0.16686-0.0409)

=$34.28240758

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

=2.832102/1.16686+3.427693051/1.16686^2+4.1485369/1.16686^3+34.28240758/1.16686^3

=$29.13(Approx).