Question

Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 38.00% 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:

Estimated current stock price is $46.84

Step-by-step explanation:

First we have to find the value of dividend payment $t_1, t_2 \& t_3$

Given $D_0= 1.75$

Yearly growth rate for next 2 years( $g_1$ )=38.00%

$D_1=\ 1.75\times 1.38=\ 2.42$

$D_2=\ 2.42\times1.38=\ 3.34$

Growth after two years will 6% indefinitely

$g_2=6\%=\dfrac{6}{100}=0.06$

$D_3=\ 3.34\times1.06=\ 3.54$

Estimate of current stock price is

$=\dfrac{D_1}{(1+r)}+\dfrac{D_2}{(1+r)^{2}}+\dfrac{\dfrac{D_3}{(r-g_2)}}{(1-r)^{3}}$

$=\dfrac{\ 2.42}{(1.12)}+\dfrac{\ 3.34}{(1.12)^{2}}+\dfrac{\dfrac{\ 3.54}{(0.12-0.06)}}{(1.12)^{3}}$

=$46.84

Estimate of current stock price is =$46.84