Question

The dividend for Should I, Inc., is currently $1.65 per share. It is expected to grow at 12 percent next year and then decline linearly to a perpetual rate of 3 percent beginning in four years. If you required a return of 15 percent on the stock, what is the most you would pay per share?

Answer 1

Current Dividend, D0 = $1.65

Growth rate for year 1 is 12%, for year 2 is 9%, for year 3 is 6% and for year 4 and onward a constant growth rate (g) of 3%.

D1 = $1.6500 * 1.12 = $1.8480
D2 = $1.8480 * 1.09 = $2.0143
D3 = $2.0143 * 1.06 = $2.1352
D4 = $2.1352 * 1.03 = $2.1993

Required Return, rs = 15%

P3 = D4 / (rs - g)
P3 = $2.1993 / (0.15 - 0.03)
P3 = $2.1993 / 0.12
P3 = $18.3275

P0 = $1.848/1.15 + $2.0143/1.15^2 + $2.1352/1.15^3 + $18.3275/1.15^3
P0 = $16.58

Therefore, current stock price is $16.58