Question

Minuet Industries just paid a dividend of D0 = $1.00. Analysts expect the company's dividend to grow by 20% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 8.00%. What is the best estimate of the stock’s current market value? $40.59 $39.65 $38.75 $41.85 $42.99

Answer 1

Answer:

$41.85

Explanation:

According to the dividend valuation model , the current price of a stock is the present  value of the expected future dividends discounted at the required rate of return

This principle can be applied as follows:

Year 1     1.00× 1.20 × 1.08^(-1)     =  $1.11

Year 2    1.00× 1.20 × 1.1 ×1.08^(-2)     =  $1.131

PV of year of year 3 onward

This will e done in two steps:

Year 3 on ward

Step 1

Calculate the PV of dividend in year 2 terms

=  1.00 × 1.20 × 1.10 × 1.05 =1.08^(-3) = $46.2

Step 2

Re-discount the  PV (in year 2) to year 0

46.2 × 1.08 ^(-2) = 39.60

Stock price = 1.11 + 1.131 + 39.60

=$ 41.85