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A company currently pays a dividend of $2.75 per share (D0 = $2.75). It is estimated...

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Finance

A company currently pays a dividend of $2.75 per share(D0 = $2.75). It is estimated that the company'sdividend will grow at a rate of 21% per year for the next 2 years,and then at a constant rate of 6% thereafter. The company's stockhas a beta of 2, the risk-free rate is 7.5%, and the market riskpremium is 6%. What is your estimate of the stock's current price?Do not round intermediate calculations. Round your answer to thenearest cent.

Answer & Explanation Solved by verified expert
3.7 Ratings (466 Votes)

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 7.5 + 2 * (6)
Expected return% = 19.5
Required rate= 19.50%
Year Previous year dividend Dividend growth rate Dividend current year Horizon value Total Value Discount factor Discounted value
1 2.75 21.00% 3.3275 3.3275 1.195 2.7845
2 3.3275 21.00% 4.026275 31.614 35.640275 1.428025 24.95774
Long term growth rate (given)= 6.00% Value of Stock = Sum of discounted value = 27.74
Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 2 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor
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