Question

Magnetic Corporation expects dividends to grow at a rate of 14.7% for the next two years. After two years dividends are expected to grow at a constant rate of 3.8%, indefinitely. Magnetic’s required rate of return is 14.6% and they paid a $1.43 dividend today. What is the value of Magnetic Corporation’s common stock per share? (Show your answers to the nearest cent)

Answer 1

The value of the stock today is $16.63.

Step-by-step explanation:

The value of the common stock today can be calculated using the DDM approach. As the dividends are growing at a certain rate for some period of time before the growth rate becomes constant, the two stage growth model will be used. Th formula for value/price under two stage dividend growth model is,

P0 or V0 = D1 / (1+r) + D2/(1+r)^2 + ... + [Dn * (1+g) / (r - g)] / (1+r)^n

Thus, V0 = 1.43 * (1+0.147) / (1+0.146) + 1.43 * (1+0.147)^2 / (1+0.146)^2 + [{1.43 * (1+0.147)^2 * (1+0.038)} / (0.146 - 0.038)] / (1+0.146)^2

V0 = $16.63