Question

A stock is expected to pay a dividend of $3.00 at the end of the year (i.e., D1 = $3.00), and it should continue to grow at a constant rate of 10% a year. If its required return is 14%, what is the stock's expected price 5 years from today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

$120.79

Step-by-step explanation:

Using dividend growth model, we have

P0 =
`(D1)/(Ke - g)`

P0 = Current market price

D1 = Dividend at the end of year 1

Ke = Required rate of return

g = growth rate

Now in the given case, Ke is constant @ 14%

g is also constant @ 10%

For price at the end of 5 years = P5

We need to calculate D6

D6 = (((((D1 +g) + g) + g) + g) + g)

= (((((3 +10%) +10%) + 10%) +10%) +10%)

= 4.83153

Therefore Expected price at the end of 5 years =
`(4.83153)/(0.14-0.10)`

= $120.79