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Current share price of a stock?
Pepsi's annual dividend is expected to grow at 10% per year for the next two years, after which time the growth rate will be constant at 5%. If the required return for the stock is 12% and the most recent dividend was $3, what should be the current share price? (You may assume that the next dividend will be exactly one year from now.)
Im not sure how to start this question. I am confused about the annual dividend part. If it grows at 10% then what is the rate?
1 Answer
- MohammadLv 77 years agoFavorite Answer
1. Dividend after 2 years = Present dividend(1+0.1)^2 Or
Dividend after 2 years = 3(1.21) = $3.63
2. The formula for Gordon growth model is:
P = D1/(r-g)
The variables are: P is the current stock price. g is the constant growth rate in perpetuity expected for the dividends. r is the constant cost of equity capital for that company. D1 is the value of the next year's dividends. There is no reason to use a calculation of next year's dividend using the current dividend and the growth rate, when management commonly disclose the future year's dividend and websites post it.
http://en.wikipedia.org/wiki/Gordon_model
3. Applying values to the above formula, we get:
Price = 3.63/(0.12-0.05) .... (12%=0.12; 5%=0.05) OR
Price = 3.63/(0.07) = $51.86
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Source(s): As Above . .
