Question

Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 22.00% 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

Current Stock Price = $40.66 approx.

Step-by-step explanation:

Given : Last dividend i.e
`D_(0)` = $1.75

Growth rate i.e g = 22%

Required Rate of return i.e K = 12%

`D_(1)` = 1.75 (1 + .22) = 2.135

`D_(2)` = 2.135 ( 1 + .22) = 2.6047

`D_(3)` = 2.6047 ( 1 + .06) = 2.7609

As per dividend growth rate model, the current stock price can be calculated as follows;

=
`(D_(1) )/((1\ +\ K)^(1) ) \ +\ (D_(2) )/((1\ +\ K)^(2) ) \ + \ (1)/((1\ +\ K)^(2) ) *\ [(D_(3) )/(K\ -\ g) ]`

=
`(2.135 )/((1\ +\ .12)^(1) ) \ +\ (2.6047 )/((1\ +\ .12)^(2) ) \ + \ (1)/((1\ +\ .12)^(2) ) *\ [(2.7609 )/(.12\ -\ .06) ]`

= 3.9827 + 36.6828

= $40.66

Thus, the current market price of the given stock is $40.66 approx.