posted by Teresa on .
A common stock is just paid an annual dividend of $2 yesterday. The dividend is expeccted to grow at 8% annually for the next 3 years, after which is will grow at 4% in perpetuity. The appropriate discount rate is 12%. What is the priceof the stock?
What I know:
Present Value of all Div as of yr end 0 is 20.82 + 32.76 =
??? not sure about this step
Perhaps my reply to your previous question would help. On the other hand perhaps I am way off base not being a financial type at all.
by the way, my g for geometric series is starting value.
my r is ratio of value at year (n+1) to value at year n.
in that case sum of infinite series is g/(1-r)
by the way, for just n terms
sum = g + g r + g r^2 +...+ g r^(n-1)
= g (1-r^n)/(1-r)
let's see what the dividends are worth after 3 years (n = 4 because we start at the beginning of year one and the end of the other years)
V3 = 2 + 2(1.08/1.12) + 2(1.08/1.12)^2...
g = 2
r = 1.08/1.12 = .9463
sum after three years = 2(1-.9463^3)/(1-.9463) = 2(.1526/.0537) = 5.683
now we go on forever at 4%
g = 5.683
r = 1.04/1.12 = .9286
sum to infinity = 5.683/(1-.9286) = 79.56
wait a minute, we have to subtract the first three years at 4% off the infinite 4% years because we did those years separately with 8%
sum at 4% after three = 2(1-.9286^3)/(1-.9286)
= 2*(.1993/.0714) = 5.583
so it is
79.56 - 5.58 = 73.98