1. A company currently pays a dividend of $1.75 per share, D 0 = 1.75. It is est

Question

1. A company currently pays a dividend of $1.75 per share, D0 = 1.75. It is estimated that the company's dividend will grow at a rate of 15% percent per year for the next 2 years, then the dividend will grow at a constant rate of 8% thereafter. The company's stock has a beta equal to 1.3, the risk-free rate is 4.5 percent, and the market risk premium is 5 percent. What is your estimate is the stock's current price? Round your answer to the nearest cent.

2.A stock is trading at $70 per share. The stock is expected to have a year-end dividend of $6 per share (D1 = 6), and it is expected to grow at some constant rate g throughout time. The stock's required rate of return is 12 percent. If markets are efficient, what is your forecast of g? Round the answer to the nearest hundredth.

Explanation / Answer

1. A company currently pays a dividend of $1.75 per share, D0 = 1.75. It is estimated that the company's dividend will grow at a rate of 15% percent per year for the next 2 years, then the dividend will grow at a constant rate of 8% thereafter. The company's stock has a beta equal to 1.3, the risk-free rate is 4.5 percent, and the market risk premium is 5 percent. What is your estimate is the stock's current price? Round your answer to the nearest cent.

Required rate of return = 4.5+5*1.3 = 11%

Stock's current price = (1.75*1.15)/1.11 + (1.75*1.15*1.15)/1.11^2 + {(1.75*1.15*1.15*1.08)/(0.11-0.08)}/1.11^2 = $71.31

2.A stock is trading at $70 per share. The stock is expected to have a year-end dividend of $6 per share (D1Â = 6), and it is expected to grow at some constant rate g throughout time. The stock's required rate of return is 12 percent. If markets are efficient, what is your forecast of g? Round the answer to the nearest hundredth.

D1=6,P0=70, Ke=12%, g=?

We have P0=D1/(Ke-g)

ie Ke-g = D1/P0

So g = Ke - D1/P0 = 12% - 6/70 = 3.429%

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