Question

Gruber Corp. pays a $9 dividend on its stock. The company will maintain this dividend for the next 3 years. In year 4, the dividend will increase to $10 and then grow at a constant 5 percent rate annually into perpetuity. If the required return on this stock is 10 percent, what is the current share price?

Answer 1

Answer:

Share price Today = $172.574

Explanation:

Using dividend growth model we can compute price of share after 3 years,

As follows:

$P_3 = \frac{D_4}{K_e - g}$

Where P3 = Price at end of year 3

D4 = Dividend at end of year 4 = $10

Ke = Cost of return = 10%

g = growth rate = 5%

P3 = $\frac{10}{0.10-0.05}$ = $200

Now, we have

Year    Dividend or price        Present value factor          Present Value

1                     $9                                0.909                                $8.181

2                    $9                                0.826                                $7.434

3                    $9                                0.751                                  $6.759  

3                    $200                           0.751                                  $150.20

Net Present value of share today = $172.574