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A company currently pays a dividend of $2.25 per share (D0 = $2.25). It is estimated...

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Finance

A company currently pays a dividend of $2.25 per share (D0 =$2.25). It is estimated that the company's dividend will grow at arate of 17% per year for the next 2 years, and then at a constantrate of 6% thereafter. The company's stock has a beta of 1.2, therisk-free rate is 6%, and the market risk premium is 4%. What isyour estimate of the stock's current price? Do not roundintermediate calculations. Round your answer to the nearestcent.

Answer & Explanation Solved by verified expert
3.7 Ratings (658 Votes)

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 6 + 1.2 * (4)
Expected return% = 10.8
Required rate= 10.80%
Year Previous year dividend Dividend growth rate Dividend current year Horizon value Total Value Discount factor Discounted value
1 2.25 17.00% 2.6325 2.6325 1.108 2.3759
2 2.6325 17.00% 3.080025 68.017 71.097025 1.227664 57.91245
Long term growth rate (given)= 6.00% Value of Stock = Sum of discounted value = 60.29
Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 2 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

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Transcribed Image Text

A company currently pays a dividend of $2.25 per share (D0 =$2.25). It is estimated that the company's dividend will grow at arate of 17% per year for the next 2 years, and then at a constantrate of 6% thereafter. The company's stock has a beta of 1.2, therisk-free rate is 6%, and the market risk premium is 4%. What isyour estimate of the stock's current price? Do not roundintermediate calculations. Round your answer to the nearestcent.

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