Tom company’s last dividend was $1.25. The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 8% forever. If the firm’s required return (rs) is 11%, what is its current stock price?
A) If Da, D2, D3 are the dividends for the first three years, Then,
D1 = $1.25*1.15 = $1.4375
D2 = $1.25* (1.15^2) = $1.653125
D3 = $1.25* (1.15^3) = $1.90109375
With the second stage growth or G2 = 8%, and required rate of return, or r = 11% Stock value (using multi-stage dividend growth model) = $54.07
current stock price = 54.07
Working motes for the above answer is as under
We have been provided with the information that
Do =1.25
Now we will calculate D1,D2,D3 as follow
| D0 | 1.25 |
| D1 | 1.4375 |
| D2 | 1.653125 |
| D3 | 1.90109375 |
Or they are given the sum itself
1 = $1.25*1.15 = $1.4375
D2 = $1.25* (1.15^2) = $1.653125
D3 = $1.25* (1.15^3) = $1.90109375
Now find
D4
=1.90*(1.08)
=$ 2.053
Now calculate price at P3
P3 .
= D4 /k-g
= 2.053 / 0.11 -0.08
=
$ 68.44
Now we will find the present value of each dividend and P3 as follow
| AmounT | PV factor@ 11% |
Prasent Value | |
| D1 | 1.438 | 0.900900901 | 1.295045 |
| D2 | 1.653 | 0.811622433 | 1.341713 |
| D3 | 1.901 | 0.731191381 | 1.390063 |
| P3 | 68.44 | 0.731191381 | 50.04274 |
| 54.06956 |
current stock price = 54.07
