Question

Growing, Inc. is a firm that is experiencing rapid growth. The firm yesterday paid a dividend of $7.70. You believe that dividends will grow at a rate of 25.0% per year for two years, and then at a rate of 5.0% per year thereafter. You expect the stock will sell for $35.09 in two years. You expect an annual rate of return of 23.0% on this investment. If you plan to hold the stock indefinitely, what is the most you would pay for the stock now

Answer 1

$38.98

Step-by-step explanation:

The maximum amount a rational investor would pay for the stock is the present value of its future dividends and the present value of the terminal value of dividends beyond year 2(the price at the end of year 2) discounted at the investor's rate of return which is 23.0%

Year 1 dividend=$7.70*(1+25.0%)=$9.63

Year 2 dividend=$9.63*(1+25.0%)=$12.04

Share price at the end of year 2=$35.09(the 5.0% is of no use since terminal value beyond has been given)

price of the stock=$9.63/(1+23.0%)^1+$12.04/(1+23.0%)^2+$35.09/(1+23.0%)^2

price of the stock=$38.98