Question

Assume today is December 31, 2019. Imagine Works Inc. just paid a dividend of $1.25 per share at the end of 2019. The dividend is expected to grow at 15% per year for 3 years, after which time it is expected to grow at a constant rate of 6% annually. The company's cost of equity (rs) is 9.5%. Using the dividend growth model (allowing for nonconstant growth), what should be the price of the company's stock today (December 31, 2019)

Answer 1

Answer:

Value of stock = $47.99

Explanation:

The price of a stock using the dividend valuation model is the present value of the the future dividend expected from the stock discounted at the required rate of return.

Year                                   Present Value  

1    1.25× 1.15^1 × 1.095^(-1) =1.31

2    1.25× 1.15^2 × 1.095^(-2) = 1.38

3.    1.25× 1.15^3 × 1.095^(-3)= 1.45

Present value of Dividend in Year 4 and beyond

This will be done in two steps

Step 1

PV in year 3 terms  

= Dividend in year 4× (1.06)/(0.095-0.06)

1.25× 1.15^3 × 1.06/(0.095-0.06)=57.57

PV in year 0 terms =

PV in year 3 × 1.095^(-3)

=57.5759 × 1.095^(-3)= 43.852

Value of stock = 1.3  + 1.38 + 1.45  + 43.852= $47.99

Value of stock = $47.99