R&D Technology Corporation just paid a dividend of $0.50 per share. Analysts expect its dividend to grow at 24 percent per year for the next two years and then 8 percent per year thereafter. If the required rate of return in the stock is 16 percent, calculate the current value of the stock.

Question

Quizplus · Accepted Answer

Using the dividend discount model:

Year 1 Dividend = $0.50 x 1.24 = $0.62
Year 2 Dividend = $0.62 x 1.24 = $0.77

After year 2, dividends grow at 8% per year.

Year 3 Dividend = $0.77 x 1.08 = $0.83
Year 4 Dividend = $0.83 x 1.08 = $0.90
Year 5 Dividend = $0.90 x 1.08 = $0.97
Year 6 Dividend = $0.97 x 1.08 = $1.05

Using the constant growth dividend discount model:

PV of dividends for years 1-2: 
$0.62 / (1 + 0.16) + $0.77 / (1 + 0.16)^2 = $1.1368

PV of dividends from year 3 onwards: 
$1.05 / (0.16 - 0.08) / (1 + 0.16)^2 = $6.6833

Current stock value = PV of dividends for years 1-2 + PV of dividends from year 3 onwards 
= $1.1368 + $6.6833 
= $7.82

Therefore, the best choice is C: $8.82, which is the closest value to the calculated value of $7.82.

R&D Technology Corporation Just Paid a Dividend of $0