Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?

Question

Quizplus · Accepted Answer

$\begin{array}{r}
\text {Last dividend }\left(\mathrm{D}_{0}\right) &\$ 1.75 \
\text {Short-run growth rate  } &25 \% \
\text {Long-run growth rate  } &6 \% \
\text {Required return } &12 \%
\end{array}$ 
 $\begin{array}{lcccc}
\text { Year } & 0 & 1 & 2 & 3 \
\hline & & 25.00 \% & 25.00 \% & 6.00 \% \
\text { Dividend } & \$ 1.7500 & \$ 2.1875 & \$ 2.7344 & \$ 2.8984 \
\text { Horizon value }=\mathrm{D}_{3} /\left(\mathrm{r}_{\mathrm{S}}-\mathrm{g}_{3}\right)= & & 48.3073 & & \
\hline \text { Total CFs } & & \$ 2.1875 & \$ 51.0417 & \
\mathrm{PV} \text { of CFs } & & \$ 1.9531 & \$ 40.6901 &
\end{array}$ 
Price = Sum of PVs = $42.64

Orwell Building Supplies' Last Dividend Was $1