Question

Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 22.00% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?

Answer 1

Answer:

Current Stock Price = $40.66 approx.

Explanation:

Given : Last dividend i.e $D_{0}$ =  $1.75

            Growth rate i.e g = 22%

            Required Rate of return i.e K = 12%

$D_{1}$ = 1.75 (1 + .22) = 2.135

$D_{2}$ = 2.135 ( 1 + .22) = 2.6047

$D_{3}$ = 2.6047 ( 1 + .06) = 2.7609

As per dividend growth rate model, the current stock price can be calculated as follows;

= $\frac{D_{1} }{(1\ +\ K)^{1} } \ +\ \frac{D_{2} }{(1\ +\ K)^{2} } \ + \ \frac{1}{(1\ +\ K)^{2} } *\ [\frac{D_{3} }{K\ -\ g} ]$

= $\frac{2.135 }{(1\ +\ .12)^{1} } \ +\ \frac{2.6047 }{(1\ +\ .12)^{2} } \ + \ \frac{1}{(1\ +\ .12)^{2} } *\ [\frac{2.7609 }{.12\ -\ .06} ]$

= 3.9827 + 36.6828

= $40.66

Thus, the current market price of the given stock is $40.66 approx.