A company is expected to have a temporary supernormal growth period and then level off to a normal growth rate forever. The supernormal growth is expected to be 25% for 2 years, 20% for 1 year and then level off to 8% forever. ke=14% and the company last paid a $2.00 dividend. What would the market be willing to pay for the stock today? a) $67.50 b) $47.09 c) $52.68
I get answer b but apparently it is c…why??
DIV1=2.5 DIV2=3.125 DIV3=3.75 DIV4=4.05 (you need it to get Price at year 3) Price yr3= 4.05/(14%-8%)= 67.5 now discount back DIV1/(1+R) + DIV2/(1+R)^2 + (DIV3+Price yr3)/(1+R)^3
To add to nalzaki, you can get the Price at Year 3 by using the Dividend Growth Model which equals DIV4/(k-g).
It is so obvious! Thanks guys. I don’t know what the heck I was doing wrong…I can’t find the paper where I did the initial calculations, but I tried it again and got it right. Thanks again.