Question

A company will pay a $2 per share dividend in 1 year. The dividend in 2 years will be $4 per share, and it is expected that dividends will grow at 2% per year thereafter. The expected rate of return on the stock is 16%. a. What is the current price of the stock?

Answer 1

$26.35

Step-by-step explanation:

Use dividend discount model (DDM) to solve this question.

First, find the present value of each year's dividend;

PV (of D1 ) = 2/ (1.16) = 1.7241

PV (of D2 ) = 4/ (1.16²) = 2.9727

Yr 3 dividend (D3) = D2(1+g) = 4(1+0.02) = 4.08

PV (of D3 ) =
`((4.08)/(0.16-0.02) )/(1.16^(2) )`

PV (of D3) = 29.1429/1.3456 =21.6579

Next, to find price, sum up the present values;

1.7241 + 2.9727 + 21.6579 = 26.35

Therefore, the current price of the stock is $26.35