Note: You must keep all decimal places to correctly solve this problem. Nonconst

Question

Note: You must keep all decimal places to correctly solve this problem.

Nonconstant Growth Valuation

A company currently pays a dividend of $3 per share (D0 = $3). It is estimated that the company's dividend will grow at a rate of 16% per year for the next 2 years, then at a constant rate of 7% thereafter. The company's stock has a beta of 1.05, the risk-free rate is 6.5%, and the market risk premium is 4%. What is your estimate of the stock's current price? Round your answer to the nearest cent.

$  

Note: You must keep all decimal places to correctly solve this problem.

Nonconstant Growth Valuation

A company currently pays a dividend of $3 per share (D0 = $3). It is estimated that the company's dividend will grow at a rate of 16% per year for the next 2 years, then at a constant rate of 7% thereafter. The company's stock has a beta of 1.05, the risk-free rate is 6.5%, and the market risk premium is 4%. What is your estimate of the stock's current price? Round your answer to the nearest cent.

$  

Note: You must keep all decimal places to correctly solve this problem.

Explanation / Answer

Ans:

Required rate of return = Risk free rate+Beta*Risk premium = 6.5%+1.05*4% = 10.7%

Dividend in year 1 = $3(1+0.16) = $3.48, PV of dividend = $3.48/(1+0.107) = $3.1436

Dividend in year 2 = $3.48(1+0.16) = $4.0368, PV of dividend = $4.0368(1+0.107)2 = $3.2941

Terminal value at the end of year 2 = As per Dividend growth model

= Next year dividend/(Required rate of return-growth rate)

= $4.0368(1+0.07)/(0.107-0.07) = 4.31938/0.037=$116.7399

PV of terminal value = $116.7399/(1+0.107)2 = $95.2630

So the current stock price = PV of future cash flow = $3.1436+$3.2941+$95.2630 = $101.7 (ans)

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