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    4368 Note10

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    Sankalan Ghosh
    This document contains two examples of stock valuation using a non-constant dividend growth model. The first example calculates the current price of a stock with an initial dividend of $1, expected growth of 20% then 15% for the next two years, and then 5% constant growth. The current stock price is $18.827. The second example finds the current price of a stock with dividends of $3, $3.75, $4.6875 for the first three years, and then 5% constant growth. The required rate of return is 12% and the current stock price is $59.04.

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    4368 Note10

    Uploaded by

    Sankalan Ghosh
    41 views2 pages
    This document contains two examples of stock valuation using a non-constant dividend growth model. The first example calculates the current price of a stock with an initial dividend of $1, expected growth of 20% then 15% for the next two years, and then 5% constant growth. The current stock price is $18.827. The second example finds the current price of a stock with dividends of $3, $3.75, $4.6875 for the first three years, and then 5% constant growth. The required rate of return is 12% and the current stock price is $59.04.

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    This document contains two examples of stock valuation using a non-constant dividend growth model. The first example calculates the current price of a stock with an initial dividend of $1, expected growth of 20% then 15% for the next two years, and then 5% constant growth. The current stock price is $18.827. The second example finds the current price of a stock with dividends of $3, $3.75, $4.6875 for the first three years, and then 5% constant growth. The required rate of return is 12% and the current stock price is $59.04.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    41 views2 pages

    4368 Note10

    Uploaded by

    Sankalan Ghosh
    This document contains two examples of stock valuation using a non-constant dividend growth model. The first example calculates the current price of a stock with an initial dividend of $1, expected growth of 20% then 15% for the next two years, and then 5% constant growth. The current stock price is $18.827. The second example finds the current price of a stock with dividends of $3, $3.75, $4.6875 for the first three years, and then 5% constant growth. The required rate of return is 12% and the current stock price is $59.04.

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    ECO 4368

    Instructor: Saltuk Ozerturk

    Stock Valuation with Non-Constant Dividend Growth

    Example 1: Mack Industries just paid a dividend of $1.00 per share


    (i.e. D0 = $1.00). Analysts expect the companys dividend to grow
    20% this year (i.e. D1 = $1.21) and 15% next year. After 2 years, the
    dividend is expected to grow at a constant rate of 5%. The required
    rate of return on the companys stock is rs = 12%. What is the current
    price of the companys stock?

    Answer: First, let us find the expected dividend flow:

    D1 = $1.21
    D2 = 1.21(1.15) = $1.3915

    After the first two dividends, the dividend is expected to grow at a


    constant rate g = 5%. Therefore, we have

    D3 (1.3915) 1.05
    P2 = = = $20.87
    rs g 12% 5%
    Accordingly, the current stock price is given by
    D1 D2 + P2
    P0 = +
    1 + 0.12 (1 + 0.12)2
    1.21 1.3915 + 20.87
    = + = 18.827
    1 + 0.12 (1 + 0.12)2

    1
    Example 2: Stewart Industries expects to pay a $ 3.00 per share
    dividend on its common stock at the end of the year (D1 = $3.00).
    This dividend is expected to grow 25% a year for the first two years,
    i.e.,

    D2 = $3.75
    D3 = $4.6875

    after which the dividend is expected to grow at a constant rate of 5 %


    a year:
    D4 = D3 (1.05) = 4.6875(1.05) = $4.9218
    The stocks beta is 1.2, the risk-free rate of interest is 6% and the rate of
    return on the market portfolio is 11%. What is the companys current
    stock price?

    Answer: First find the required rate of return on the stock

    rs = 6% + 1.2(11% 6%) = 12%

    Now one can find P3 as


    D4 $4.9218
    P3 = = = $70.31
    rs g 12% 5%
    Accordingly, the current stock price is given by
    D1 D2 D3 + P3
    P0 = + 2 +
    1 + 0.12 (1 + 0.12) (1 + 0.12)3
    3 3.75 4.6875 + 70.31
    = + 2 +
    1 + 0.12 (1 + 0.12) (1 + 0.12)3
    = 59.04

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