Question

A fast growing firm recently paid a dividend of $1.00 per share. The dividend is expected to increase at a 25 percent rate for the next three years. Afterwards, a more stable 8 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value? Group of answer choices

A. $83.13
B. $120.24
C. $12.50
D. $75.93

Answer 1

To calculate the value of a fast-growing firm's stock, we must discount its expected future dividends to the present using a 10% discount rate, accounting for initial high growth and subsequent stable growth.

Step-by-step explanation:

The value of a stock is based on the present discounted value (PDV) of its expected future dividends. In the case described, we need to calculate the value of a fast-growing firm's stock, given its dividend growth rates and a 10% discount rate.

To find the stock's value, we calculate the PDV of dividends for each of the next three years with the 25% growth rate, and then calculate the terminal value of the stock at the end of the third year using the perpetuity formula with the 8% stable growth rate. These future values are then discounted back to present value using the 10% discount rate. The combined present value of these amounts gives us the value of the stock.