Question

Burton corp. is growing quickly. dividends are expected to grow at a rate of 28 percent for the next three years, with the growth rate falling off to a constant 6.9 percent thereafter. if the required return is 16 percent and the company just paid a dividend of $3.20, what is the current share price? (hint: calculate the first four dividends.)

Answer 1

The current share price is $62.23.

Step-by-step explanation:

We have:

+ Dividend at the end of Year 1 = 3.2 x 1.28 = $4.096;

+ Dividend at the end of Year 2 = 3.2 x 1.28^2 = $5.243;

+ Dividend at the end of Year 3 = 3.2 x 1.28^3 = $6.711.

=> From year 03, dividend will be growing at 6.9% annually; which dividend at the end of year 4 is $7.174 ( 6.711 x 1.069)

Current share price is equal to the dividend stream discounting at the required rate of return 16% which is calculated as:

Current share price = 4.096/1.16 + 5.243/1.16^2 + 6.711/1.16^3 + [ 7.174 / ( 0.16 - 0.069) ] / 1.16^3 = $62.23.

So, the answer is $62.23.

Answer 2

Current year Dividend (D0) = $3.20

Dividend for the first year (D1) = $3.20*(1.28) = $4.10

Dividend for the second year (D2) = $3.20*(1.28)^2 = $5.24

Dividend for the third year (D3) = $3.20*(1.28)^3 = $6.71

Dividend for the fourth year (D4) = $3.20*(1.069)^4 = $7.17

Price of the third year (P3) = $7.17/(0.16-0.069) = $78.83

Current Price of the year (P0) = $4.10/(1+0.16)^1 + $5.24/(1+0.16)^2 + $6.71/(1+0.16)^3 + $78.83/(1+0.16)^3

P0 = $64.34