Stock Valuation with Non-constant Growth of the Dividend using DDM. The last ann

Question

Stock Valuation with Non-constant Growth of the Dividend using DDM. The last annual dividend paid by Starboard Industries was Do = $1.15. The company's growth rate is expected to be 30 percent for each of the next 3 years, followed by a constant rate of 8 percent, indefinitely. Investors require a return of Ri = 13.4 percent. What is the expected annual dividend for each of the next three years, respectively? (Hint: this question is asking for Future, Uneven Cash Flows)

For the situation described above, what is the current theoretical price of the stock or Po? (Hint: solve by using NPV in excel, or by using CF key on the calculator, or treat as several Lump Sums with their own Present Values that can be added together to determine the Net Present Value or NPV.)

Explanation / Answer

1) Expected annual dividend for each of the next three years:

1st year = 1.15*1.3 = $1.50

2nd year = 1.5*1.3 = $1.95

3rd year = 1.95*1.3 = 2.54

2) Terminal value = 2.54*1.08/(0.134 - 0.08) = 2.74/0.054 = 50.74

Price of the stock at t=0 = 1.5/1.134 + 1.95/1.134^2 + 2.54/1.134^3 + 50.74/1.134^3 = $39.38

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