Question

Sudberry Systems Corp. is launching a new product that analysts expect will propel its growth to 18% for about a year. After that everyone expects the firm to return to a more normal 5% growth rate indefinitely. Sudberry recently paid an annual dividend of $3.50. Similar stocks are currently returning 9%. What is the most an investor should be willing to pay for a share of Sudberry?

Answer 1

To determine the most an investor should be willing to pay for a share of Sudberry, we can use the dividend discount model (DDM) which values a stock based on the present value of its expected future dividends.

Step-by-step explanation:

To determine the most an investor should be willing to pay for a share of Sudberry, we can use the dividend discount model (DDM) which values a stock based on the present value of its expected future dividends.

First, we need to calculate the future dividends. Since Sudberry is expected to grow at 18% for one year and then return to a 5% growth rate indefinitely, we can calculate the dividends by multiplying the current dividend by the expected growth rate each year.

Next, to find the present value of these dividends, we calculate the discounted dividend cash flows by dividing the future dividend by the required rate of return. Finally, we sum up the present values of the dividends to find the intrinsic value of the stock. This value represents the most an investor should be willing to pay for a share of Sudberry.