Question

Hi-Tek is a young start-up company. No dividends will be paid on the stock over the next 9 years, because the firm needs to plow back its earnings to fuel growth. The company plans to pay a $6 per share dividend in 10 years (that is, at t = 10) and will increase the dividend by 4 percent per year thereafter. What is the current share price if the required return on this stock is 14 percent?

Answer 1

Current share price = $18.45

Step-by-step explanation:

The Dividend Valuation Model is a technique used to value the worth of a stock . According to this model, the value of a stock is the sum of the present values of the future dividends discounted at the required rate of return.

The share price would be determined using the dividend valuation model as follows:

P = Do×(1+g)/(ke-g)

P- price , Ke- cost of equity, g- growth rate in dividend

P-? g- 4%, Ke- 14%, D(1+g) = future dividend

Price in year 9 = 6/(0.14-0.04)

=$60

Price today

To calculate the price today, the price in year 9 would be discounted at the rate of 14% per annum.

Price now = 60 × (1.14)^(-9)

= $18.45

Answer 2

The price of the stock today is $16.83

Step-by-step explanation:

The current price per share can be estimated using constant growth model of the DDM. The price per share can be calculated using the following formula,

P0 = D1 / r - g

To calculate the price today, we use the dividend expected for the next period. Thus, using the dividend that will be paid at t=11 or D11, we can calculate the price of the stock at t=10. We further need to discount this price using the required rate of return for 10 years to calculate the price of the stock today.

P10 = 6 * (1+0.04) / (0.14 - 0.04)

P10 = $62.4

The price of the stock today will be,

P0 = 62.4 / (1.14)^10

P0 = $16.83