You buy a share of The Ludwig Corporation stock for $22.00. You expect it to pay

Question

You buy a share of The Ludwig Corporation stock for $22.00. You expect it to pay dividends of $1.02, $1.17, and $1.3421 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $30.51 at the end of 3 years.

Calculate the growth rate in dividends. Round your answer to two decimal places.
%

Calculate the expected dividend yield. Round your answer to two decimal places.
%

Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to obtain the expected total rate of return. What is this stock's expected total rate of return (assume the market is in equilibrium with the required return equal to the expected return)? Round your answer to two decimal places.
%

Nonconstant Growth Stock Valuation

Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $0.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 75% per year - during Years 4 and 5. After Year 5, the company should grow at a constant rate of 6% per year. If the required return on the stock is 16%, what is the value of the stock today (assume the market is in equilibrium with the required return equal to the expected return)? Round your answer to the nearest cent. Do not round your intermediate computation

Explanation / Answer

Growth rate in dividends (g)= (1.17-1.02)/1.02= 14.7 %

Expected divided yield(Dy) = D3/P3 = 1.3421 /30.51 = 4.39 %

Expected total rate of return of stock = Dy + g = 4.39% + 14.7% = 19.09 %

Using dividend discount model,

Dividend in year 3, D3 = $ 0.75

D4 = 0.75*(1+0.75) = $1.3125

D5 = 1.3125*1.75 =$ 2.2968

Continuing value of Dividends , D5 continuing = 2.2968*(1+6%)/(16%-6%) = 24.346

So Value of stock today = 0.75/(1+16%)^3 + 1.3125/(1+16%)^4 + 2.2968/(1+16%)^5 + 24.346/(1+16%)^5

= $ 13.89

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