Problem 85 Nonconstant Growth Valuation A company currently

Problem 8-5
Nonconstant Growth Valuation

A company currently pays a dividend of $3.5 per share (D0 = $3.5). It is estimated that the company\'s dividend will grow at a rate of 15% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company\'s stock has a beta of 1.55, the risk-free rate is 7%, and the market risk premium is 6%. What is your estimate of the stock\'s current price? Round your answer to the nearest cent.

Solution

using CAPM required return=risk free rte+ beta*risk premium required return=7+ 1.55*6 required return= 16.30 Amount Discount factor Present value Dividend for 1st year 3.5*1.15 4.025 0.859845 3.460877 Dividend for 2nd year 4.025*1.15 4.62875 0.739334 3.422191 Dividend for 3rd year 4.62875*1.05 4.860188 Price after 2 year 4.860/(.163-.05) 43.01051 0.739334 31.79912 Stock price today 38.68