Question

A tech start-up company has just become public. It just paid $3 dividend per share, which will grow 10% for the next two dividends. Afterwards, the dividends will level off and grow at 4% per year forever. If the investors require 6% return on similar investments, what is the price of stock

Answer 1

P0 = $174.3396226 rounded off to $174.34

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 = 3 * (1+0.1) / (1+0.06) + 3 * (1+0.1)^2 / (1+0.06)^2 +

[(3 * (1+0.1)^2 * (1+0.04) / (0.06 - 0.04)) / (1+0.06)^2]

P0 = $174.3396226 rounded off to $174.34