Analysts forecast that ABC,Inc will pay a dividend of $2.50 a share now, continu

Question

Analysts forecast that ABC,Inc will pay a dividend of $2.50 a share now, continuing a long-term growth trend of 10% per year. If this trend is expected to continue indefinitely, and investors' required rate of return for ABC is 12%: What is the market value per share of ABC's common stock? What is the market value per share of ABC's common stock if required rate of return is 16%? If there is expected to be non-constant growth of 20% for the first year, then 18% for the next year, then 16% for the next year, finally stabilizing to a constant growth of 10% per year in the 4th year what is the market value per share?

Explanation / Answer

Answer:

a. When current dividend is $ 2.50 per share with constant growth of 10% and investors required rate of return is 12% then,

Market Price of Share = Expected Dividend / Investors required rate of return

here, expected dividend shall be calculated by using indefinite growth formula = $ 2.50 / 10% = $ 25 per share and Market Price = $ 25 / 12% = $ 208.33 alternately it can be calculated as $ 25 / (12% - 10%) = $ 1,250 per share.

b. If required rate of return is 16% then,

Market Price = $ 25 / 16% = $ 156.25 per share or $ 25/ (16% - 10%) = $ 416.67 per share.

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