Question

Burke tires just paid a dividend of $2.42. analysts expect the company's dividend to grow by 30% this year, 20% next year (year 2), 10% the following year (year 3), and then 5% in each subsequent year. if the required return to the stock is 8.3%, what is the best estimate of the stock's current market value (please enter the value to the penny)?
a. $60.34.
b. $59.48.
c. $59.91.
d. $58.62.
e. $59.05.

Answer 1

Answer:

There is no correct answer is these options. But the correct answer is $113.41

Explanation:

The formula to solve this is:

Po = D1/r - g

Po is the Current price of the common stock

D1 is the future dividend payment

r is the rate of return

g is the growth rate.

This is quite different from the usual(single stage). This is Two-stage Dividend Discount Model. To solve this;

D1(Dividend in year 1) is $3.15( $2.42 x 1.3)

D2(Dividend in year 2) is $3.78(3.15 x 1.2)

D3(Dividend in year 3) is $4.15($3.78 x 1.1)

D in subsequent years is $4.36(4.15 x 1.05)

P3(price of stock in year 3) = $4.36/0.083 - 0.05

=$132.12

Now the stock's current market value is

$3.15/1.08 + $3.78/1.08^2 + $4.15/1.08^3 + $132.12^3

The price of the stock is $113.41