Question

Given the following information, calculate the current value of the stock: current dividend is $3.00, projected super normal growth for three years at 20%, growth rate after year 3 should remain constant at 11% and you want to earn a 16% annual return. What should you pay for the stock?

A.$67.55
B.$83.34
C.$74.39
D.$61.46

Answer 1

B. $83.34

Step-by-step explanation:

Current Dividend (D0) = $3.00

Super Normal growth for next three years (g1) = 20% = 0.20

Growth Rate after three year (g2) = 11% = 0.11

Required rate of Return (r) = 16% or 0.16

P3 = D4/(r-g2) = D0*(1+g1)^3*(1+g2)/(r-g2)

P3 = $3.00*(1+0.20)^3*(1+0.11)/(0.16-0.11)

P3 = $115.0848

Value of Share (P0) = [D1/(1+r)] + [D2/(1+r)^2] + [D3/(1+r)^3] + [P3/(1+r)^3]

Value of Share (P0) = [D0*(1+g1)/(1+r)1] + [D0*(1+g1)^2/(1+r)^2] + [D0*(1+g1)^3/(1+r)^3] + [P3/(1+r)^3]

Value of Share (P0) = [$3.00*(1+0.20)/(1+0.16)^1] + [$3.00*(1+0.20)^2/(1+0.16)^2] + [$3.00*(1+0.20)^3/(1+0.16)^3] + [$115.0848/(1+0.16)^3]

Value of Share (P0) = $3.10 + $3.21 + $ 3.32 + $73.72

Value of Share (P0) = $83.34