Equity (stock price value)

I do not fully understand the logic behind “what the market be willing to pay for stock today” when there are multiple dividend payments. In the following example, I mistakenly think that I should account for the 8% normal growth rate, when I should not. Thanks in advance for your help!

Q) Bybee is expected to have a temporary supernormal growth period and then level off to a “normal,” sustainable growth rate forever. The supernormal growth is expected to be 25 percent for 2 years, 20 percent for one year and then level off to a normal growth rate of 8 percent forever. The market requires a 14 percent return on the company and the company last paid a $2.00 dividend. What would the market be willing to pay for the stock today?


C) $52.68. First, find the future dividends at the supernormal growth rate(s). Next, use the infinite period dividend discount model to find the expected price after the supernormal growth period ends. Third, find the present value of the cash flow stream.

D1 = 2.00 (1.25) = 2.50 (1.25) = D2 = 3.125 (1.20) = D3 = 3.75 P2 = 3.75/(0.14 - 0.08) = 62.50 N = 1; I/Y = 14; FV = 2.50; compute PV = 2.19. N = 2; I/Y = 14; FV = 3.125; compute PV = 2.40. N = 2; I/Y = 14; FV = 62.50; compute PV = 48.09. Now sum the PV’s: 2.19 + 2.40 + 48.09 = $52.68.

The soln looks correct. What’s wrong in this?

For giggles, in Excel I put in 200 years of dividends (the last of which is . . . wait for it . . . just over $14,400,000), and the PV of those dividends is $52.69.

I’d say that you nailed it.

as an aside, learn how to calculate the PVs using the cash flow register of your calculator:

CF0=0; C01=2.50; C02=3.125+62.50 = 65.625; NPV@14%=??=52.69

Once you’ve calculated the dividends and stock price, it saves you a bit of time (Relative to calculating individual PVS and summing them). It als involves fewer calcualtions, so there’s less chance of making an error.