ABC common stock is expected to have extraordinary growth of 20% per year for 2 years,at which time the growth rate will settle into a constant 6%.If the discount rate is 15% and the most recent dividend was $2.50,what should be the approximate current share price?
A) $31.16
B) $33.23
C) $37.42
D) $47.77

Question

Quizplus · Accepted Answer

We can first calculate the expected dividends for the next 2 years using the extraordinary growth rate of 20%:

Year 1: $2.50 x 1.20 = $3.00
Year 2: $3.00 x 1.20 = $3.60

After the second year, the growth rate will settle down to 6%. To calculate the present value of these future cash flows, we can use the dividend discount model:

PV = D1/(1+r) + D2/(1+r)^2 + (D3/(r-g))/(1+r)^2

PV = $3.00/(1.15) + $3.60/(1.15)^2 + ($3.60 x 1.06)/(0.15 - 0.06)/(1.15)^2
PV = $2.61 + $2.74 + $32.07
PV = $37.42

Therefore, the approximate current share price would be $37.42, which is closest to choice C.

ABC Common Stock Is Expected to Have Extraordinary Growth of 20