Question

The dividend for Should I, Inc., is currently $1.15 per share. It is expected to grow at 20 percent next year and then decline linearly to a perpetual rate of 5 percent beginning in four years. If you required a return of 17 percent on the stock, what is the most you would pay per share? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Last Dividend, D0 = $1.15

Growth rate in year 1 is 20%, in year 2 is 15%, in year 3 is 10 and then a constant growth rate (g) of 5% forever.

D1 = $1.1500 * 1.20 = $1.3800
D2 = $1.3800 * 1.15 = $1.5870
D3 = $1.5870 * 1.10 = $1.7457
D4 = $1.7457 * 1.05 = $1.8330

Required return, r = 17%

P3 = D4 / (r - g)
P3 = $1.8330 / (0.17 - 0.05)
P3 = $1.8330 / 0.12
P3 = $15.275

P0 = $1.3800/1.17 + $1.5870/1.17^2 + $1.7457/1.17^3 + $15.275/1.17^3
P0 = $12.97

So, maximum price paid for this stock is $12.97