Assume that the average firm in your company\'s industry is expected to grow at

Question

Assume that the average firm in your company's industry is expected to grow at a constant rate of 5% and that its dividend yield is 6%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $1.25. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 25% during the second year (g1,2 = 25%). After Year 2, dividend growth will be constant at 5%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Explanation / Answer

Dividend at year 1 = $ 1.25 x 1.5 = $ 1.875

Dividend at year 2 = $ 1.875 x 1.25 = $ 2.34

Dividend at year 3 = $ 2.34 x 1.05 = $ 2.46

Required dividend yield = 6% and growth rate = 5%

Value per share at the end of year 3 = Dividend in year 3 / (required yield - growth)

Value per share at the end of year 3 = 2.46 / (0.06 - 0.05) = 246

This value is further pulled by 3 years = 246/1.06/1.06/1.06 = 206.54

Present Value of Dividend of year 1 & 2 - 1.875/1.06 + 2.34/1.06/1.06 = 3.85

Estimated present value per share of the firm's stock = 206.54 + 3.85 = $ 210.39

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