Question

A stock just paid a dividend of $3. The stock is expected to increase its dividend payment by 30% per year for the next 3 years. After that, dividends will grow at a rate of 8% forever. If the required rate of return is 10%, what is the price of the stock today?

Answer 1

Price of stock today = $334.56

Step-by-step explanation:

The Dividend Valuation Model(DVM) 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 would that arise from the asset discounted at the required rate of return.

This model would be applied as follows:

Year Present Value ( PV)

1 3 × 1.3 × 1.1^(-1) = 3.5454

2 3 × 1.3^2 × 1.1^(-2) = 4.1900

3 3 × 1.3^3 × 1.1^(-3) = 4.9519

Total 12.6874

Year 4 and beyond

This will be done in two steps

Step 1

D× (1+g)/k-g

3 × 1.3^4/(0.1-0.08)

=428.415

Step 2

Present Value in year 0

=428.415 × 1.1^(-3) = 321.87

Total present value = 12.6874 + 321.87 = 334.56

Price of stock today = $334.56