Question

A stock will pay no dividends for the next 3 years. Four years from now, the stock is expected to pay its first dividend in the amount of $2.2. It is expected to pay a dividend of $2.7 exactly five years from now. The dividend is expected to grow at a rate of 6% per year forever after that point. The required return on the stock is 13%. The stock's estimated price per share exactly TWO years from now, P₂ , should be $______.

Do not round any intermediate work, but round your final answer to 2 decimal places (ex: $12.34567 should be entered as 12.35).

Answer 1

The stock price is computed as shown below:

= Dividend in year 3 / (1 + required rate of return)¹ + Dividend in year 4 / (1 + required rate of return)² + Dividend in year 5 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 5 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 0 / 1.13 + $ 2.2 / 1.13² + $ 2.7 / 1.13³ + 1 / 1.13³ [ ( $ 2.7 x (1 + 0.06) / ( 0.13 - 0.06) ]

= $ 0 / 1.13 + $ 2.2 / 1.13² + $ 2.7 / 1.13³ + 1 / 1.13³ [ $ 40.88571429 ]

= $ 0 / 1.13 + $ 2.2 / 1.13² + $ 43.58571429 / 1.13³

= $ 31.93 Approximately

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