Garcia Inc.has a current dividend of $3.00 per share (D₀ = $3.00).Analysts expect that the dividend will grow at a rate of 25 percent a year for the next three years,and thereafter it will grow at a constant rate of 10 percent a year.The company's cost of equity capital is estimated to be 15 percent.What is the current stock price of Garcia Inc.?

Question

Quizplus · Accepted Answer

The stock price is calculated using the dividend discount model. First, calculate the dividends for the next three years: D1 = $3.75, D2 = $4.6875, D3 = $5.859375. Then, calculate the price at the end of year 3 using the constant growth formula: P3 = D4 / (r - g) = $6.4453125 / (0.15 - 0.10) = $128.90625. Discount these cash flows back to the present value: P0 = $3.75/(1.15) + $4.6875/(1.15^2) + ($5.859375 + $128.90625)/(1.15^3) = $95.42.