Question

Biarritz Corp. is growing quickly. Dividends are expected to grow at a rate of 31 percent for the next three years, with the growth rate falling off to a constant 6.1 percent thereafter.

If the required return is 12 percent and the company just paid a dividend of 2.80, what is the current share price?

Round answer to 2 decimal places

Answer 1

Step-1, Dividend per share for the next three years

Dividend in Year 0 (D0) = $2.80 per share

Dividend in Year 1 (D1) = $3.6680 per share [$2.80 x 131%]

Dividend in Year 2 (D2) = $4.8051 per share [$3.6680 x 131%]

Dividend in Year 3 (D3) = $6.2947 per share [$4.8051 x 131%]

Step-2, Calculation of Stock Price in Year 3 (P3)

Dividend Growth Rate (g) = 6.10% per year

Required Rate of Return (Ke) = 12.00%

Therefore, the Stock Price in Year 3 (P3) = D3(1 + g) / (Ke – g)

= $6.2947(1 + 0.0610) / (0.12 – 0.0610)

= $6.6786 / 0.0590

= $113.20 per share

Step-3, Current Price of the share

The Current price of the share is the present value of future dividend plus the present value of the share price in year 3

Year	Cash flow ($)	Present Value factor at 12.00%	Present Value of cash flows ($)
1	3.6680	0.892857	3.28
2	4.8051	0.797194	3.83
3	6.2947	0.711780	4.48
3	113.20	0.711780	80.57
TOTAL			92.16

“Hence, the current share price will be $92.16”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.