Question

Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 38.00% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?

Answer 1

Estimated current stock price is $46.84

Explanation:

First we have to find the value of dividend payment
`t_1, t_2 \& t_3`

Given
`D_0=$1.75`

Yearly growth rate for next 2 years(
`g_1` )=38.00%

`D_1=\$1.75* 1.38=\$2.42`

`D_2=\$2.42*1.38=\$3.34`

Growth after two years will 6% indefinitely

`g_2=6\%=(6)/(100)=0.06`

`D_3=\$3.34*1.06=\$3.54`

Estimate of current stock price is

`=(D_1)/((1+r))+(D_2)/((1+r)^(2))+((D_3)/((r-g_2)))/((1-r)^(3))`

`=(\$2.42)/((1.12))+(\$3.34)/((1.12)^(2))+((\$3.54)/((0.12-0.06)))/((1.12)^(3))`

=$46.84

Estimate of current stock price is =$46.84