A stock that currently does not pay a dividend is expected to pay its first dividend of $1.00 five years from today. Thereafter, the dividend is expected to grow at an annual rate of 25% for the next three years and then grow at a constant rate of 5% per year thereafter. The required rate of return is 10.3%. The value of the stock today is closest to: A) $20.65. B) $22.72. C) $23.87. Could someone demonstrate how this can be solved with a financial calculator? Thanks!
On the BA II Plus, I would use the CF function (I assume you are familiar with typing those values in):
You have zero cash flows in the first 4 periods. Then:
CF5=1
CF6=1.25
CF7=38.41
Then you press NPV, and provide the 10.3% as the IRR, and you get: 20.65
CF7 can be computed as follows:
The dividend in the 7th period: 1.25^2
The present value in the 7th period of the future dividends received in the 8th period (and thereafter) period: 1.25^3/(10.3%-5%)=36.85
Add those two together = 1.25^2 + 36.85=38.41
Notice, you could also let the dividend in the 8th period grow at the constant rate for one period to arrive in period 9 and then compute the present value of those future payments in period 8, will get you the same result.