Question

A company currently pays a dividend of $1 per share (D0 = $1). It is estimated that the company's dividend will grow at a rate of 25% per year for the next 2 years, and then at a constant rate of 6% thereafter. The company's stock has a beta of 1.3, the risk-free rate is 8.5%, and the market risk premium is 4%. What is your estimate of the stock's current price?

Answer 1

To estimate the stock's current price, we can use the Gordon Growth Model, which is a version of the Dividend Discount Model. First, we need to calculate the dividends for the next two years: D1 = D0 * (1 + g) = $1 * (1 + 0.25) = $1.25 and D2 = D1 * (1 + g) = $1.25 * (1 + 0.25) = $1.5625.

Next, we calculate the price at the end of year 2 using the Gordon Growth Model: P2 = D3 / (k - g) = D2 * (1 + 0.06) / (0.085 + 1.3 * 0.04 - 0.06) = $1.65625 / 0.037 = $44.7696.

Finally, we discount the dividends and price back to the present: P0 = D1 / (1 + k) + D2 / (1 + k)^2 + P2 / (1 + k)^2 = $1.25 / (1 + 0.085 + 1.3 * 0.04) + $1.5625 / (1 + 0.085 + 1.3 * 0.04)^2 + $44.7696 / (1 + 0.085 + 1.3 * 0.04)^2.

Please note that this is a simplified calculation and the actual price may vary based on other factors.