Question

A stock expects to pay a dividend of $4.32 per share next year. The dividend is expected to grow at 25 percent per year for three years followed by a constant dividend growth rate of 4 percent per year in perpetuity. What is the expected stock price per share 5 years from today, if the required return is 12 percent

Answer 1

P5 = $114.075 rounded off to $114.08

Step-by-step explanation:

The DDM will be used to calculate the price of the stock. 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+g) / (r - g)

Where,

• g is the constant growth rate

• D0 is the dividend paid today or most recently and D0 * (1+g) equals D1 which is dividend expected for the next year

• r is the required rate of return

As we use D0 * (1+g) or D1 to calculate the value of the stock today (P0), we will use D6 to calculate the value of the stock 5 years from now.

D1 = 4.32

D6 = 4.32 * (1+0.25)^3 * (1+0.04)

^2

D6 = $9.126

P5 = 9.126 / (0.12 - 0.04)

P5 = $114.075 rounded off to $114.08