Question

Savickas Petroleum's stock has a required return of 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock's expected constant growth rate after t = 4, i.e., what is X?

Answer 1

Answer:

6.38%

Explanation:

The computation of the stock expected constant growth rate is shown below:

But before that first we have to find out the dividend for each year by considering the growth rate

Dividend for year 1  = $1 × (1 + 0.30) = $1.30

Dividend for year 2 = $1 × (1 + 0.30)^2 = $1.69

Dividend for year 3 = $1 × (1 + 0.30)^3 = $2.197

Dividend for year 4 = $1 × (1 + 0.30)^4 = $2.8561

and, the selling price of the stock is $40

So,

$1.30 × 0.8929 + $1.69 × 0.7972 + $2.197 × 0.7118 + $2.8561 × 0.6355) + [$2.8561 × (1 +X%) ÷ 12% - X%)] = $40

After solving this

The X is 6.38%

And, the discount rate is come from

= 1 ÷ (1 + interest rate)^number of years

Like 0.8929 is come from

= 1 ÷ (1 + 0.12)^1