The value of any asset is the present value of all future cash flows expected to be generated from the asset. Hence, if we can find the present value of the dividends during the period preceding long-run constant growth and subtract that total from the current stock price, the remaining value would be the present value of the cash flows to be received during the period of long-run constant growth.
D1 = $2.00 ´ (1.25)1 = $2.50 PV(D1) = $2.50/(1.12)1 = $2.2321
D2 = $2.00 ´ (1.25)2 = $3.125 PV(D2) = $3.125/(1.12)2 = $2.4913
D3 = $2.00 ´ (1.25)3 = $3.90625 PV(D3) = $3.90625/(1.12)3 = $2.7804
S PV(D1 to D3)= $7.5038
Therefore, the PV of the remaining dividends is: $58.8800 – $7.5038 = $51.3762. Compounding this value forward to Year 3, we find that the value of all dividends received during constant growth is $72.18. [$51.3762(1.12)3 = $72.1799 » $72.18.] Applying the constant growth formula, we can solve for the constant growth rate:
