Question

A company currently pays a dividend of $2.2 per share (D0 = $2.2). It is estimated that the company's dividend will grow at a rate of 22% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.4, the risk-free rate is 6.5%, and the market risk premium is 2%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Estimate of the stock's current price=$132.71

Step-by-step explanation:

Price of the stock today =
`(D1)/((1+ke)^1)+(D2)/((1+ke)^2)+(D3)/((1+ke)^3)+(P3)/((1+ke)^3)`.

where
`D_1= D_0*(1+g)=2.2(1.22)=2.684`

and ke using CAPM =
`r_f+b(r_m-r_f)` = 0.065+1.4(0.02)=0.093

and P3=
`(D4)/(ke-g)`

Estimate of the stock's current price =
`(2.684)/((1+0.093)^1)+(2.684(1.22))/((1+0.093)^2)+(2.684(1.22)(1.07))/((1+0.093)^3)+(2.684(1.22)(1.07^2))/((0.093-0.07)(1+ke)^3)` = 132.71