Question

A company currently pays a dividend of $4 per share (D0= $4). It is estimated that the company’s dividend will grow at a rate of 10% per year for the next 2 years, and then at a constant rate of 5% thereafter. The company’s stock has a beta of 6, the risk-free rate is 4% and the market risk premium is 2%. What is your estimate of the stock’s current price? Please solve in Excel. Thank you!

Answer 1

First we calculate the required return as per CAPM:

return=risk free+ (Beta*Market risk premium)
Market risk premium=Market return-risk free rate)

Return=4+(6*2)=16%

Dividend year 1=4.00*1.10=4.40

Year	Div	Terminal value	Total		Discount factor		Present Value
1	$ 4.4000		$     4.40		0.847457627		$                 3.73
2	$ 4.8400	$            46.2000	$   51.04		0.71818443		$               36.66
3	$ 5.0820				0.608630873		$                      -
4						Total	$          40.3849

Discount factors (DF)are calculated as:1/(1+r)^n

Where r is required return and n is the year

For the perpetual growth period, terminal value (TV) of dividends = Dividend next period/(r-g) where r is the required return and g is the growth rate.

Terminal value of dividends= 5.082/(0.16-0.05)=$46.20