Question

Thirsty Cactus Corp. just paid a dividend of $1.35 per share. The dividends are expected to grow at 25 percent for the next 6 years and then level off to a 7 percent growth rate indefinitely. Required : If the required return is 14 percent, what is the price of the stock today? Multiple Choice

a) $46.24
b) $35.86
c) $47.18
d)$3.96

Answer 1

The current price of a share of Thirsty Cactus Corp. can be found by using the Dividend Discount Model, considering the high growth phase for the initial 6 years and a constant growth phase afterwards, and discounting back to the present value at the required rate of return. The price comes out to be $47.18.The correct answer is option c.

Step-by-step explanation:

The value of a share of Thirsty Cactus Corp. given its expected dividend growth rates can be calculated using the Dividend Discount Model (DDM). Here's how you can compute it:

1. Calculate the present value of dividends during the high growth phase (first 6 years).
2. Use the Gordon Growth Model to calculate the present value of all dividends after the high growth phase.
3. Sum the present values from steps 1 and 2 to find the current stock price.

Given that the dividend is expected to grow at 25% for the next 6 years, we discount each dividend back to its present value at the required return rate of 14%. After the 6 years, we assume the dividends will grow at a perpetual rate of 7%. We use the Gordon Growth Model to calculate the terminal value of the stock at the end of year 6, which is then discounted back to its present value.

Based on the calculations according to this model, the correct option for the price of the stock today would be (c) $47.18.