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A company currently pays a dividend of $2.25 per share (D0 = $2.25). It is estimated...

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Finance

A company currently pays a dividend of $2.25 per share(D0 = $2.25). It is estimated that the company'sdividend will grow at a rate of 15% per year for the next 2 years,and then at a constant rate of 5% thereafter. The company's stockhas a beta of 1.8, the risk-free rate is 5%, and the market riskpremium is 5%. What is your estimate of the stock's current price?Do not round intermediate calculations. Round your answer to thenearest cent.

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4.1 Ratings (704 Votes)

Calculation of required return:
Required return= Risk free rate+beta*market risk premium
                                =5+1.8*5= 14%
Calculation of current price:
Year Cashflows PVF @14% Present value
1                       2.59 0.877                       2.27
2                       2.98 0.769                       2.29
2                     34.72 0.769                     26.70
Total                     31.26
Current price is $31.26
Working:
Dividend at year 1= 2.25*(1+0.15)= 2.59
Dividend at year 2= 2.59*(1+0.15)= 2.98
Terminal value= Dividend(1+growth)/(return-growth)
                              =2.98*(1+0.05)/(0.14-0.05)
                             =3.129/0.09=34.72
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