Question

just paid a dividend of D0 = $1.20. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 8.00%. What is the best estimate of the stock's current market value?

Answer 1

D0 = 1.2
Required rate of return (Ke )= 8% or 0.08
Growth for year 1 = 30% or 0.30
Growth for year 2 = 10% or 0.10
Growth thereafter = 5% or 0.05
D1 = D0 *(1+g)
D1 = 1.20 * (1 + 0.30) = 1.56
D2 = D1 *(1+0.10) = 1.716
D3 = D2 *(1+0.05) =1.8018
Price of stock at end of Year 2 (P2) = D3/(Ke -g)
1.8018/(0.08 - 0.05)
60.06
Current market price today is present value of stock that is equal to present value of dividend received upto 2 Years and Price of stock received at end of 2 Year

Year	Cash flows	P.V.F.@ 8%	Cash flows * PVF
1 (D1)	1.56	0.9259259259	1.444444444
2 (D2)	1.716	0.8573388203	1.471193416
2 (P2)	60.06	0.8573388203	51.49176955
Current value			54.40740741
so, best estimate of current market value is $54.41
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