Assume that the average firm in your company\'s industry is expected to grow at
ID: 2618069 • Letter: A
Question
Assume that the average firm in your company's industry is expected to grow at a constant rate of 5% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $3. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 20% during the second year (g1,2 = 20%). After Year 2, dividend growth will be constant at 5%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.
Explanation / Answer
Required return=Dividend yield+Growth rate
(5+8)=13%
D1=(3*1.5)=$4.5
D2=(4.5*1.2)=$5.4
Value after year 2=(D2*Growth rate)/(Required return-Growth rate)
=(5.4*1.05)/(0.13-0.05)=$70.875
Value of stock=Future dividends*Present value of discounting factor(13%,time period)
=4.5/1.13+5.4/1.13^2+70.875/1.13^2
which is equal to
=$63.72(Approx).