A company currently pays a dividend of $2 per share (D = $2). It is estimated that the company’s dividend will grow at a rate Answer

A company currently pays a dividend of $2 per share (D = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?

 

Ans:

Stock Required rate of return = rs = 0.075+ 1.2 * 0.04 = 12.3 %

 D0 = $2 , D1 = 2 * 1.2 = $ 2.40, D2 = 2.4 * 1.2 = $ 2.88

 D3 = $ 3.0816

 P2 = D3 /(rs – g)   = 3.0816 /(0.123 – 0.07)   = $ 58.14

 PV of dividend D1 discounted at rs = 2.4/1.123 = $2.137

PV of dividend D2 discounted at rs = 2.88/(1.123)^2 = $ 2.284

PV of Horizon Value = 58.14/(1.123)^2 = $ 46.101

 Stock’s current price = $2.137 + $ 2.284 + $ 46.101 = $ 50.53