A stock analyst has the following forecast of dividend payou

A stock analyst has the following forecast of dividend payouts for the next three years. After the third year, he expects the dividend to grow at a constant rate of 4% a year. Using a 12% required rate of return on the stock, what is the analyst estimate of the current stock price? Year Expected dividend $0.75 $1.50 $250 2 1) $25.96 2) $26.78 3) $27.21 ) $27.47

Solution

Value after year 3=(D3*Growth rate)/(Required return-Growth rate)

=(2.5*1.04)/(0.12-0.04)=$32.50

Hence current stock price=Future dividends*Present value of discounting factor(12%,time period)

=0.75/1.12+1.5/1.12^2+2.5/1.12^3+32.50/1.12^3

which is equal to

=$26.78(Approx).