Question

A company currently pays a dividend of $2 per share. it is estimated that the company's dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. the required rate of return is 12.3%. what is your estimate of the stock's current price?

Answer 1

To estimate the current price of a share of Babble, Inc., an investor would calculate the present value of future dividends over the next two years before the company is disbanded. Considering the given profits, the shares, and a hypothetical 15% rate of return, the estimated price per share would be approximately $256,500.

Step-by-step explanation:

To estimate the current stock price for Babble, Inc., an investor would calculate the present value of future dividends since the company will be disbanded in two years. We are given that profits, and hence dividends, are expected to be $15 million immediately, $20 million after one year, and $25 million after two years. The company has 200 shares of stock.

First, we calculate the present value of the dividends for each year independently using the required rate of return, which serves as the discount rate. In this case, let's use a hypothetical required rate of return of 15%:

• Present value of immediate dividends: $15 million / 200 shares = $75,000 per share (not discounted as it is immediately available)
• Present value of first year dividends: ($20 million / (1 + 0.15)) / 200 shares = $86,956.52 per share
• Present value of second year dividends: ($25 million / (1 + 0.15)2) / 200 shares = $94,520.55 per share

Next, we sum these present values to get the total present value per share:

$75,000 + $86,956.52 + $94,520.55 = $256,477.07

Hence, the estimated price per share an investor might be willing to pay for Babble, Inc. is approximately $256,500, considering the rounded figure.

Answer 2

Stock price = $62.564

Step-by-step explanation:

The Discounted Cash flow (DCF) Model; This is a technique used to value the worth of an asset. According to this model, the value of an asset is the sum of the present values of the future cash flows that would arise from the asset discounted at the required rate of return. Using this model,

PV of dividend in year 1 = 2× 1.2×(1.123^-1) = 2.1371

PV of dividend in year 2= (2× 1.2^2×(1.123^-2) =2.2836

PV of dividend in year 3 and beyond = D(1+g)/(r-g)

r-12.3% , g- 7%

=2× 1.2^2× 1.07/(0.123-0.07)=58.14339623

Total PV = 2.1371 +2.2836 + 58.1433= 62.56419695

Stock price = $62.564