Question

NewTech Incorporated management plans on paying the company's first dividend of $2.00 three years from today (D3 = $2.00) on its' common stock. After year three the dividend is expected to grow at a constant rate of 5% thereafter. As an investor with a required rate of return of 15%, what would you pay for NewTech common stock today?

Answer 1

Stock price today = $13.807

Step-by-step explanation:

According to the dividend valuation model , the current price of a stock is the present value of the expected future dividends discounted at the required rate of return

This principle can be applied as follows:

The value of cash flow the stock today is the present value of the future cash flow discounted at the required rate of return

Step 1 : Compute the PV in year 3 of future dividend

PV = D× (1+g)/r-g

D- div in year 3, g- growth rate, r-required rate of return

PV in year 3 = 2× (1.05)/0.15-0.05

= 21

Step 2: PV in year in year 0

PV = PV in year 3 × (1+r)^(-n)

r-rate of return- 15%, n- number of years- 3

= 21 × 1.15^(-3)

=13.80784088

Stock price today = $13.807