Question

The Ramirez Company's 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?a. $41.58.b. $42.64.
c. $43.71.d. $44.80.e. $45.92.

Answer 1

Answer:

option b is correct

current stock price is $42.64

Explanation:

given data

dividend = $1.75

growth rate = 25% for 2 year

growth rate 1 = 6%

required return 2 = 12%

to find out

current stock price

solution

we will find here first stock price after 2 year that is

stock price = cash flow at 2 year end × ( 1+rate ) / ( rate 2 - rate1 )    ..................1

so here  cash flow at 2 year end = 1.75×1.25 = 2.1875

2.1875 × 1.25 = 2.734

stock price = 2.734  × ( 1+ 0.06 ) / ( 0.12 - 0.06 )  

stock price = 48.30

so stock price at 0.12 return

= cash flow at 1 year / ( 1+ rate 2 ) + cash flow at 2 year / ( 1+ rate 2 )² + stock price / ( 1+ rate 2 )²

= 2.1875 / ( 1+ 0.12 ) +  2.734 / ( 1+ 0.12 )² + 48.30 / ( 1+ 0.12 )²

= $42.64

so option b is correct

current stock price is $42.64