Question

A company currently pays a dividend of $2.2 per share (D0 = $2.2). It is estimated that the company's dividend will grow at a rate of 22% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.4, the risk-free rate is 6.5%, and the market risk premium is 2%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Answer:

Estimate of the stock's current price=$132.71

Explanation:

Price of the stock today = $\frac{D1}{(1+ke)^1}+\frac{D2}{(1+ke)^2}+\frac{D3}{(1+ke)^3}+\frac{P3}{(1+ke)^3}$.

where $D_1= D_0*(1+g)=2.2(1.22)=2.684$

and ke  using CAPM = $r_f+b(r_m-r_f)$ = 0.065+1.4(0.02)=0.093

and P3= $\frac{D4}{ke-g}$

Estimate of the stock's current price = $\frac{2.684}{(1+0.093)^1}+\frac{2.684(1.22)}{(1+0.093)^2}+\frac{2.684(1.22)(1.07)}{(1+0.093)^3}+\frac{2.684(1.22)(1.07^2)}{(0.093-0.07)(1+ke)^3}$ = 132.71