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The High Growth Company's last dividend was $1.50. The dividend growth rate is expected to be...

Question:

The High Growth Company's last dividend was $1.50. The dividend growth rate is expected to be constant at 30% for 3 years, after which dividends are expected to grow at a rate of 6% forever.

If High Growth's required return is 13%, what is the company's current stock price?

Dividend Growth and Stock Price:

One way to estimate the price of a stock is to calculate the present value of future dividend payments, discounted at the required rate of return. According to this model, the price of a stock increases with the growth rate of dividends.

Answer and Explanation:

According to the dividend discount model, the price of a stock is the discounted present value of future dividends. Applying this approach, the price of the stock is:

  • {eq}\displaystyle \sum_{t=1}^{3}{\dfrac{1.5*(1 + 30\%)^t}{(1 + 13\%)^t}} + \sum_{t=4}^{\infty}{\dfrac{1.5*(1 + 30\%)^3*(1 + 6\%)^{t-3}}{(1 + 30\%)^t}}\\ = 5.99 + 34.58\\ =40.57 {/eq}

That is, the price of the stock is $40.57.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
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