Question

The Highfield Company is going through a five-year of fast growth at 20% initially, and then it will grow at a perpetual rate of 4%. The required rate of return is 10% and it just paid a dividend of $2. What is the stock price today?
a) 43.88
b) 86.26
c) 66.64
d) 31.5

Answer 1

Answer:

P0 = $66.6429 rounded off to $66.64

Option c is the correct answer

Explanation:

Using the two stage growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula to calculate the price of the stock today is,

P0 = D0 * (1+g1) / (1+r)  +  D0 * (1+g1)^2 / (1+r)^2  +  ...  +  D0 * (1+g1)^n / (1+r)^n  +  [(D0 * (1+g1)^n * (1+g2) / (r - g2)) / (1+r)^n]

Where,

• g1 is the initial growth rate

• g2 is the constant growth rate

• r is the required rate of return

P0 = 2* (1+0.2) / (1+0.1)  +  2 * (1+0.2)^2 / (1+0.1)^2  +  2 * (1+0.2)^3 / (1+0.1)^3  

+  2 * (1+0.2)^4 / (1+0.1)^4  +  2 * (1+0.2)^5 / (1+0.1)^5  +

[(2 * (1+0.2)^5 * (1+0.04)  /  (0.1 - 0.04)) / (1+0.1)^5]

P0 = $66.6429 rounded off to $66.64