Question

synovec co. is growing quickly. dividends are expected to grow at a rate of 30 percent for the next three years, with the growth rate falling off to a constant 5 percent thereafter. If the required return is 11 percent, and the company just paid a dividend 2.8, what is the current share price?

Answer 1

Answer:

P0 = $90.3328 rounded off to $90.33

Explanation:

The two stage growth model of DDM can be used to calculate the price of the share today. The DDM values a stock based on the present value of the expected future dividends from the stock. The price of this stock under this model can be calculated as follows,

P0 = D0 * (1+g1) / (1+r) +  D0 * (1+g1)^2 / (1+r)^2  +  D0 * (1+g1)^3 / (1+r)^3

+  [ (D0 * (1+g1)^3 * (1+g2) / (r - g2)) / (1+r)^3 ]

Where,

• g1 is the initial growth rate which is 30%

• g2 is the constant growth rate which is 5%

• r is the required rate of return

P0 = 2.8 * (1+0.3) / (1+0.11)  +  2.8 * (1+0.3)^2 / (1+0.11)^2  +  

2.8 * (1+0.3)^3 / (1+0.11)^3  +

[ (2.8 * (1+0.3)^3 * (1+0.05) / (0.11 - 0.05)) / (1+0.11)^3 ]

P0 = $90.3328 rounded off to $90.33

P0 = $13.33