A stock has paid dividends of $1.50, $1.60, $1.72, and $1.80 in the last 4 years

Question

A stock has paid dividends of $1.50, $1.60, $1.72, and $1.80 in the last 4 years. Today the company paid a dividend of $2.00. If you buy the stock today, you will get the first dividend after one year. Due to an exciting project, the anticipated growth rate in dividends and earnings is 25% for the next 2 years before settling down to a constant growth rate which is an average of dividend growth rate implied by the last 5 dividends. The discount rate is 12%. Calculate the expected price of the stock.

Explanation / Answer

All Amounts in $ Average Dividend Growth Rate implied by the last five dividends Year Dividend % Increase -1 1.5 0 -2 1.6 6.67% -3 1.72 7.50% -4 1.8 4.65% 0 2 11.11% 29.93% Average Growth Rate for the future = 5.99% Given that the dividend is $ 2 currently, the dividend after 3 years will be Year Dividend 0 2 1 2.5 2 3.125 3 3.312056 Since the discount rate of the capital is 12%, the current price of the stock will be 27.60 $

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