This Course\" Marks for this submission: 1.00/1.00. Suppose a common stock pays

Question

This Course" Marks for this submission: 1.00/1.00. Suppose a common stock pays dividends at the end of each period and the stock has just paid a dividend in the amount of $2.9. If the stock's dividend growth rate is 20 percent for the next two periods and then 2.9 percent per period for every period thereafter and the discount rate is 11.4 percent per period, what is the most you should pay for the the constant growth stock valuation model. of stock according to tion Answer: 15,0607 Check Marks for this submission: 0.001.00

Explanation / Answer

Dividend Paid just now = D0 = 2.9

Growth rate for next 2 years is 20%

So, Dividend Paid on year 1 = D1 = D0 *(1+20%) = 2.9 * (1+20%) = 3.48

Dividend on Year 2 = D2 = D1 *(1+20%) = 3.48 * (1+20%) = 4.176

After that the dividend growth rate till perpetuity is 2.9%

The present value of future dividends at the end of year 2 can be calculated using Constant Growth Dividend formula:

PV = Div/(R-g) where, Div = Dividend of next period, R = Discount Rate & g = Growth Rate

Here, Div = Dividend of 3rd year = 4.176 * (1 + 2.9%) = 4.297104, R = 11.4% & g = 2.9%

So, The present value of future dividends at the end of year 2 = 4.297104/(11.4% - 2.9%) = 50.55416471

PV as on today would be = 50.55416471/(1 + 11.4%)2 = 40.73676684

Present Value of D1 = 3.48/(1+11.4%) = 3.123877917

Present Value of D2 = 4.176/(1+11.4%)2 = 3.365039049

So, stock price is = 3.123877917 + 3.365039049 + 40.73676684 = $47.2257 [rounded to 4 decimals]

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