A fast growing firm recently paid a dividend of $0.80 per share. The dividend is expected to increase at a rate of 30 percent rate for the next four years. Afterwards, a more stable 7 percent growth rate can be assumed. If a 10 percent discount rate is appropriate for this stock, what is its value?
A)$60.48
B)$60.18
C)$61.34
D)$73.86

Question

Quizplus · Accepted Answer

The stock value is calculated using the dividend discount model. First, calculate the dividends for the next four years with 30% growth: D1 = $1.04, D2 = $1.352, D3 = $1.7576, D4 = $2.28488. Then, calculate the terminal value at year 4 using the stable growth rate: TV = D5 / (r - g) = $2.44482 / (0.10 - 0.07) = $81.494. Discount these cash flows to present value: PV = $1.04/(1.10) + $1.352/(1.10^2) + $1.7576/(1.10^3) + ($2.28488 + $81.494)/(1.10^4) = $60.48.

A Fast Growing Firm Recently Paid a Dividend of $0