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Nonconstant Growth Valuation A company currently pays a dividend of $1.5 per share (D0 = $1.5). It...

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Finance

Nonconstant Growth Valuation

A company currently pays a dividend of $1.5 per share (D0 =$1.5). It is estimated that the company's dividend will grow at arate of 19% per year for the next 2 years, and then at a constantrate of 5% thereafter. The company's stock has a beta of 1.95, therisk-free rate is 7.5%, and the market risk premium is 3%. 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
4.1 Ratings (844 Votes)

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 7.5 + 1.95 * (3)
Expected return% = 13.35
Required rate= 13.35%
Year Previous year dividend Dividend growth rate Dividend current year Horizon value Total Value Discount factor Discounted value
1 1.5 19.00% 1.785 1.785 1.1335 1.5748
2 1.785 19.00% 2.12415 26.711 28.83515 1.28482225 22.44291
Long term growth rate (given)= 5.00% Value of Stock = Sum of discounted value = 24.02
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

Nonconstant Growth ValuationA company currently pays a dividend of $1.5 per share (D0 =$1.5). It is estimated that the company's dividend will grow at arate of 19% per year for the next 2 years, and then at a constantrate of 5% thereafter. The company's stock has a beta of 1.95, therisk-free rate is 7.5%, and the market risk premium is 3%. What isyour estimate of the stock's current price? Do not roundintermediate calculations. Round your answer to the nearestcent.

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