Question

Thirsty Cactus Corp. just paid a dividend of $1.55 per share. The dividends are expected to grow at 25 percent for the next 8 years and then level off to a 8 percent growth rate indefinitely. Required : If the required return is 14 percent, what is the price of the stock today

Answer 1

P0 = $77.48686986 rounded off to $77.49

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 = 1.55 * (1+0.25) / (1+0.14) + 1.55 * (1+0.25)^2 / (1+0.14)^2 +

1.55 * (1+0.25)^3 / (1+0.14)^3 + 1.55 * (1+0.25)^4 / (1+0.14)^4 +

1.55 * (1+0.25)^5 / (1+0.14)^5 + 1.55 * (1+0.25)^6 / (1+0.14)^6 +

1.55 * (1+0.25)^7 / (1+0.14)^7 + 1.55 * (1+0.25)^8 / (1+0.14)^8 +

[(1.55 * (1+0.25)^8 * (1+0.08) / (0.14 - 0.08)) / (1+0.14)^8]

P0 = $77.48686986 rounded off to $77.49

P0 = $174.3396226 rounded off to $174.34