Question

Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% 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:

Best estimate of the current stock price= $42.64

Explanation:

Price of the stock today = $\frac{D1}{(1+ke)^1}+\frac{D2}{(1+ke)^2}+\frac{P2}{(1+ke)^2}$.

where P2 = $\frac{D3}{ke-g}$

D0=$1.75

D1=$1.75(1.25)

D2=$1.75(1.25)(1.25)

D3=$1.75(1.25)(1.25)(1.06)

Price of the stock today = $\frac{1.75(1.25)}{(1+0.12)^1}+\frac{1.75(1.25)(1.25)}{(1+0.12)^2}+\frac{1.75(1.25)(1.25)(1.06)}{(0.12-0.06)(1+0.12)^2}$. = $42.64