A stock currently pays a dividend of 390 per share D0 390 I

A stock currently pays a dividend of $3.90 per share (D0 = $3.90). It is estimated that the company\'s dividend will grow at a rate of 22.5% per year for the next 2 years, then at a constant rate of 6.60% thereafter. The company\'s stock has a beta of 1.70, the risk-free rate is 8.25%, and the market risk premium is 10.50%. What is your estimate of the stock\'s current price? Please show work

Solution

A stock currently pays a dividend of $3.90 per share (D0 = $3.90). It is estimated that the company\'s dividend will grow at a rate of 22.5% per year for the next 2 years, then at a constant rate of 6.60% thereafter. The company\'s stock has a beta of 1.70, the risk-free rate is 8.25%, and the market risk premium is 10.50%. What is your estimate of the stock\'s current price? Please show work

D0= 3.90* 1.225^2

D2= 5.8524 / 0.066

Price= 88.6732

Ideally the stock price should be 88.6732. However given the availability of a risk free asset and a positive beta. We have a cost of equity.

Ke = Rf + ? . (Rm