Damon Enterprises stock is currently sells for 25 per share

Damon Enterprises\' stock is currently sells for $25 per share. The stock?s dividend is projected to increase at a constant rate of 7% per year. The required rate of return on the stock, rs, is 10%. What is Damon\'s expected price 4 years from today?

Solution

Remember that the expected price is based on the future cash flows - so the value IN year 4 will be based on the expected year 5 dividend (D5)
Price4 = D5 / (r - g)

First solve for the \"next\" dividend (D1)...
Price0 = D1 / (r - g)
25 = D1 / (0.10 - 0.07)
25 * 0.03 = D1
D1 = $0.75 <this is the dividend one year from now, after 1 year of growth at 7%

Next calc the D6 ...4 MORE years of growth...
D5 = D1 * (1 + g)^4
D5 = 0.75(1.07)^4
D5 = 0.75(1.31079)
D5 = 0.98309

Then the price IN year 4...
P4 = D5 / (r - g)
P4 = 0.98309 / (0.10 - 0.07)
P4 = $32.7699, round to $32.77