Question

The Ramirez Company's last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?

Answer 1

Answer:

best estimate of the current stock price $42.64

Explanation:

given data

last dividend = $1.75

time = 2 year

dividend growth rate constant   = 25%

dividends grow = 6%

required return (rs) = 12%

solution

we get here first Cash flows for year 1 and 2  that is  

Year 1 =  1.75 ×  (1 +0.25 )  = 2.1875

Year 2  = 2.1875 × (1 +0.25 )  = 2.734

so here at year 2 end stock price will be

stock price = 2.734 × $\frac{1+0.06}{0.12-0.06}$    

stock price = 48.30

so here

Discount cash flow at rate of return 12%

current stock price = $\frac{2.1875}{1+0.12} + \frac{2.1875}{(1+0.12)^2} + \frac{48.30}{(1+0.12)^2}$

current stock price = $42.64