A fast growing firm recently paid a dividend of $1.00 per share. The dividend is expected to increase at a 25 percent rate for the next three years. Afterwards, a more stable 8 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value?

Question

Quizplus · Accepted Answer

The stock value is calculated using the dividend discount model. First, calculate the dividends for the next three years: D1 = $1.25, D2 = $1.5625, D3 = $1.953125. Then, calculate the terminal value at the end of year 3 using the formula D4/(r-g) = $2.109375/(0.10-0.08) = $105.46875. Discount these cash flows back to the present value: PV = $1.25/(1.10) + $1.5625/(1.10^2) + ($1.953125 + $105.46875)/(1.10^3) = $83.13.

A Fast Growing Firm Recently Paid a Dividend of $1