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Nonconstant Growth Stock Valuation Assume that the average firm in your company's industry is expected to grow...

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Finance

Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry isexpected to grow at a constant rate of 4% and that its dividendyield is 6%. Your company is about as risky as the average firm inthe industry and just paid a dividend (D0) of $2. Youexpect that the growth rate of dividends will be 50% during thefirst year (g0,1 = 50%) and 30% during the second year(g1,2 = 30%). After Year 2, dividend growth will beconstant at 4%. What is the estimated value per share of yourfirm’s stock? Do not round intermediate calculations. Round youranswer to the nearest cent.

Answer & Explanation Solved by verified expert
4.2 Ratings (485 Votes)

Step 1 )Required return on stock =Dividend Yield +Growth

                                             = 6 +4

                                             = 10%

Step 2)

Year Dividend Present value at 10% Dividend *Present value
1 2(1+.50) = 3 .90909 2.73
2 3(1+.30)= 3.90 .82645 3.22
Terminal value /Horizon value at year 2 67.60 .82645 55.87
estimated value per share of your firm’s stock 61.82

working :

Terminal value at year 2 =D2(1+g)/(Rs-g)

                   = 3.90(1+.04)/(.10-.04)

                   = 3.90*1.04/.06

                   = 67.60

**Fins present value factor from table at 10% or using the formula :1/(1+i)^n
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Transcribed Image Text

Nonconstant Growth Stock ValuationAssume that the average firm in your company's industry isexpected to grow at a constant rate of 4% and that its dividendyield is 6%. Your company is about as risky as the average firm inthe industry and just paid a dividend (D0) of $2. Youexpect that the growth rate of dividends will be 50% during thefirst year (g0,1 = 50%) and 30% during the second year(g1,2 = 30%). After Year 2, dividend growth will beconstant at 4%. What is the estimated value per share of yourfirm’s stock? Do not round intermediate calculations. Round youranswer to the nearest cent.

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