Question

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 32 percent for the next three years, with the growth rate falling off to a constant 6.2 percent thereafter. If the required return is 14 percent and the company just paid a dividend of $2.85, what is the current share price?

Answer 1

P0 = $71.7850 rounded off to $71.79

Step-by-step explanation:

The two stage growth model of 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 under this model is,

P0 = D0 * (1+g1) / (1+r) + D0 * (1+g1)^2 / (1+r)^2 + ... + D0 * (1+g1)^n / (1+r)^n +

[(D0 * (1+g1)^n * (1+g2) / (r - g2)) / (1+r)^n]

Where,

• g1 is the initial growth rate
• g2 is the constant growth rate
• D0 is the dividend paid today or most recently
• r is the required rate of return

P0 = 2.85 * (1+0.32) / (1+0.14) + 2.85 * (1+0.32)^2 / (1+0.14)^2 +

2.85 * (1+0.32)^3 / (1+0.14)^3 +

[(2.85 * (1+0.32)^3 * (1+0.062) / (0.14 - 0.062)) / (1+0.14)^3]

P0 = $71.7850 rounded off to $71.79