Question

Storico Co. just paid a dividend of $2.00 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on the company's stock is 17 percent, what will a share of stock sell for today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

P0 = $22.54949 rounded off to $22.55

Step-by-step explanation:

The dividend discount model or DDM will be used to calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today for a stock whose dividend grows at various rates before becoming constant is,

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

Where,

• g is the constant growth rate

P0 = 2 * (1+0.2) / (1+0.17) + 2 * (1+0.2) * (1+0.15) / (1+0.17)^2 +

2 * (1+0.2) * (1+0.15) * (1+0.1) / (1+0.17)^3 +

[(2 * (1+0.2) * (1+0.15) * (1+0.1) * (1+0.05) / (0.17 - 0.05)) / (1+0.17)^3]

P0 = $22.54949 rounded off to $22.55