The Satellite Building Company has fallen on hard times.Its management expects to pay no dividends for the next 2 years.However, the dividend for Year 3, D3, will be $1.00 per share, and the dividend is expected to grow at a rate of 3 percent in Year 4, 6 percent in Year 5, and 10 percent in Year 6 and thereafter.If the required return for Satellite is 20 percent, what is the current equilibrium price of the stock?

Question

Quizplus · Accepted Answer

The current equilibrium price of the stock is calculated by finding the present value of expected future dividends. Since dividends start in Year 3, we discount them back to the present value using the required return of 20%. The dividends grow at different rates in subsequent years, and the terminal value is calculated using the constant growth rate from Year 6 onwards. The correct calculation results in a price of $6.34.

The Satellite Building Company Has Fallen on Hard Times