Question

Ex 6) A tech start-up company has just become public. It just paid $3 dividend per share, which will grow 10% for the next two dividends. Afterwards, the dividends will level off and grow at 4% per year forever. If the investors require 6% return on similar investments, what is the price of stock

Answer 1

Answer:

Stock price today = $174.34

Explanation:

Given:

Current Dividend = $3

Growth rate in year 2 = 10% = 0.1

Growth rate in year 3 = 4% = 0.04

Computation:

Dividend in year 2 = Current Dividend(1 + Growth rate in year 2)²

Dividend in year 2 = 3(1+0.1)²

Dividend in year 2 = $3,63

Dividend in year 3 = Dividend in year 3(1 + Growth rate in year 3)

Dividend in year 3 = $3.63(1 + 0.04)

Dividend in year 3 = $3.7752

Stock Price in year 2 = Dividend in year 3 / (Investors required return - Growth rate in year 3)

Stock Price in year 2 = $3.7752 / (6% - 4%)

Stock Price in year 2 = $188.76

Stock price today = [D1 / (1 + Required return)] + [D2 / (1 + Required return)² ] + [S2 / (1 + Required return)²]

Stock price today = $174.34