For many companies, it is unreasonable to assume that dividends grow at a consta
ID: 2803207 • Letter: F
Question
For many companies, it is unreasonable to assume that dividends grow at a constant growth rate. Hence, valuation for these companies proves a little more complicated. The valuation process, in this case, requires us to estimate the short-run nonconstant growth rate and use it to predict near-term dividends. Then, we must estimate a constant long-term growth dividend growth rate. Generally, we assume that after a certain point of time, all firms begin to grow at a more-or-less constant rate. Of course, the difficulty in this framework is estimating the short-term growth rate, how long the short-term growth will hold, and then the long-term growth rate.
In general, one should predict as many future annual dividends as possible and then discount them back to the present. Then, all dividends to be received after the end of nonconstant growth (the beginning of constant growth) will be valued using the constant growth model presented above.
A company's stock just paid a $1.82 dividend, which is expected to grow at 30 percent for the next three years. After three years, the dividend is expected to grow constantly at 10 percent forever. The stock's required return is 16 percent. What is the price of the stock today?
Now, with this information...how would you explain to a nonhealthcare major why this is important and how this information is beneficial.
Last dividend paid $1.82 Required rate of return 16% Expected ST growth rate 30% Short-run E(g); for Years 1-3 only. Expected LT growth rate 10% Long-run E(g); for Year 4 and all following years. 30% 10% Year 0 1 2 3 4 Dividend $1.82 $2.37 $3.08 $4.00 $4.40 $2.04 = PV of Year 1 dividend $2.29 = PV of Year 2 dividend $2.56 = PV of Year 3 dividend $6.89 = sum of dividend PVs 73.31 = Terminal value $46.96 = PV of terminal value $53.85 = E(P0)Explanation / Answer
Year
Formula = previous year dividend*(1+r)^n
Expected dividend
0
1.82
1
1.82*1.3
2.366
2
1.82*1.3^2
3.0758
3
1.82*1.3^3
3.99854
4
3.9985*1.1
4.39835
value of stock
expected dividend/(required return-growth rate)
4.39835/(16%-10%)
73.30583
Year
1
2.366
2.039655
2
3.0758
2.28582
3
3.99854
2.561695
3
73.30583
46.96394
present value of stock
53.85112
With the help of this information one can explain that present worth of the stock on the basis of expected future cash flow is 53.85 so if the stock is trading more than the price so it would not be beneficial to buy and if it is more than the market price it would be beneficial to buy the stock.
Year
Formula = previous year dividend*(1+r)^n
Expected dividend
0
1.82
1
1.82*1.3
2.366
2
1.82*1.3^2
3.0758
3
1.82*1.3^3
3.99854
4
3.9985*1.1
4.39835
value of stock
expected dividend/(required return-growth rate)
4.39835/(16%-10%)
73.30583
Year
1
2.366
2.039655
2
3.0758
2.28582
3
3.99854
2.561695
3
73.30583
46.96394
present value of stock
53.85112
With the help of this information one can explain that present worth of the stock on the basis of expected future cash flow is 53.85 so if the stock is trading more than the price so it would not be beneficial to buy and if it is more than the market price it would be beneficial to buy the stock.
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