Question

Yang Corp. is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 18 percent and the company just paid a $2.50 dividend, what is the current share price

Answer 1

Answer:

$60.45

Explanation:

Recall that

Po = D1/r - g

Where

Po = current price of stock

D1 = net dividend expected

r = required return

g = constant growth rate

From the question, we are going to pay at super normal growth rate for 3 years followed by constant dividend policy. The value after three years can be calculated by using constant dividend growth formula and after that, present value will be calculated. Thus, current value of stock will be

= D1/(1 + r) + D2(1 + r)^2 + D3/(1 + r)^3 + D4/(r - g)(1 + r)^3

= 2.5 × 1.25/(1 + 13) + 2.5 × 1.25^2/(1 + 13)^2 + 2.5 × 1.25^3(1 + 13)^3 + 2.5 × 1.25 × 1.06/(13 - 6)(1 + 13)^3

= 2.77 + 3.06 + 3.38 + 51.24 = 60.45

Therefore, present value of stock is $60.45