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Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant...

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Finance

Orwell building supplies' last dividend was $1.75. Its dividendgrowth rate is expected to be constant at 41.00% for 2 years, afterwhich dividends are expected to grow at a rate of 6% forever. Itsrequired return (rs) is 12%. What is the best estimateof the current stock price?

Select the correct answer.

a. $50.43
b. $52.79
c. $53.97
d. $51.61
e. $49.25

Answer & Explanation Solved by verified expert
4.3 Ratings (869 Votes)

c. $53.97

As per dividend discount model, current price of stock is the present value of future dividends.
Step-1:Present value of dividend of next 2 years
Year Dividend Discount factor Present value
a b c=1.12^-a d=b*c
1 $       2.47      0.8929 $       2.20
2 $       3.48      0.7972 $       2.77
Total $       4.98
Working;
Dividend of year :
1 = $       1.75 x 1.41 = $       2.47
2 = $       2.47 x 1.41 = $       3.48
Step-2:Present value of dividends after year 2
Present value = D2*(1+g)/(K-g)*DF2 Where,
= 3.48*(1+0.06)/(0.12-0.06)*0.7972 D2 $        3.48
= $    49.01 g 6%
K 12%
DF2 0.7972
Step-3:Present value of all dividends
Present value of future dividends = $       4.98 + $     49.01
= $    53.99
Note:
Difference of $ 0.02 is due to rounding off difference.

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