Question

Huang Company's last dividend was $1.55. The dividend growth rate is expected to be constant at 22.5% for 3 years, after which dividends are expected to grow at a rate of 4% forever. If the firm's required return (rs) is 12%, what is its current stock price? Do not round intermediate calculations.

Answer 1

The current stock price of Huang Company is $40.05.

Step-by-step explanation:

To calculate the current stock price of Huang Company, we can use the formula for the present value of dividends: Stock Price = (Dividend / (Required Return - Dividend Growth Rate)). We first need to calculate the future dividends for the next 3 years using the constant dividend growth rate of 22.5%. After 3 years, we assume the dividends will grow at a rate of 4% forever. Then we can calculate the present value of these future dividends to find the current stock price.

Step 1: Calculate the future dividends for the next 3 years:

• Year 1 dividend = $1.55 x (1 + 22.5%) = $1.90
• Year 2 dividend = $1.90 x (1 + 22.5%) = $2.32
• Year 3 dividend = $2.32 x (1 + 22.5%) = $2.84

Step 2: Calculate the present value of future dividends:

• PV of Year 1 dividend = $1.90 / (1 + 12%) = $1.70
• PV of Year 2 dividend = $2.32 / (1 + 12%)^2 = $1.86
• PV of Year 3 dividend = $2.84 / (1 + 12%)^3 = $1.99

Step 3: Calculate the present value of dividends after year 3:

PV of perpetual dividend = Year 3 dividend / (Required Return - Dividend Growth Rate) = $2.84 / (12% - 4%) = $35.50

Step 4: Calculate the current stock price:

Stock Price = PV of Year 1 dividend + PV of Year 2 dividend + PV of Year 3 dividend + PV of perpetual dividend

Stock Price = $1.70 + $1.86 + $1.99 + $35.50 = $40.05