Orwell building supplies' last dividend was $1.75. Its dividend
growth rate is expected to be constant...
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Finance
Orwell building supplies' last dividend was $1.75. Its dividendgrowth rate is expected to be constant at 41.00% for 2 years, afterwhich dividends are expected to grow at a rate of 6% forever. Itsrequired return (rs) is 12%. What is the best estimateof the current stock price?
Select the correct answer.
a. $50.43
b. $52.79
c. $53.97
d. $51.61
e. $49.25
Answer & Explanation
Solved by verified expert
4.3 Ratings (869 Votes)
c. $53.97
As per dividend discount model, current price of stock is the
present value of future dividends.
Step-1:Present value of dividend of next 2 years
Year
Dividend
Discount factor
Present
value
a
b
c=1.12^-a
d=b*c
1
$ 2.47
0.8929
$ 2.20
2
$ 3.48
0.7972
$ 2.77
Total
$ 4.98
Working;
Dividend of
year :
1
=
$ 1.75
x
1.41
=
$ 2.47
2
=
$ 2.47
x
1.41
=
$ 3.48
Step-2:Present value of dividends after year 2
Present
value
=
D2*(1+g)/(K-g)*DF2
Where,
=
3.48*(1+0.06)/(0.12-0.06)*0.7972
D2
$ 3.48
=
$ 49.01
g
6%
K
12%
DF2
0.7972
Step-3:Present value of all dividends
Present value of future dividends
=
$ 4.98
+
$ 49.01
=
$ 53.99
Note:
Difference
of $ 0.02 is due to rounding off difference.
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