Stock Valuation

Question: Stock Valuation

ABC just paid a dividend of $3.00. It is expected to grow at 20% per year over the following three years, and then from Year 4 the growth rate is expected to fall to a constant rate of 7% indefinitely. Its required return is 15%. Find the value of ABC stock today.

Here we have supernormal growth for the next three years. We need to calculate the dividends during this rapid-growth period and the stockprice in three years. The dividends are:

From Year 4 the growth rate is expected to fall to a constant rate of 7% indefinitely.. The price at thattime, P3, is thus:

Now the stocks present value is the present value of the three dividends and the future price:

= $55.40

So the value of ABC stock today is $55.40.

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