Answer:
&9.66
Explanation:
From the question, we have:
Year 0 dividend = The last dividend = $1
Year 1 dividend = Year 0 dividend × (1 + expected increase in dividends in one year)
Year 1 dividend = $1 × (1 + 0.20) = $1 × 1.20 = $1.20
Year 2 dividend = Year 1 dividend × (1 + expected increase in dividends in two years)
Year 2 dividend = $1.20 × (1 + 0.15) = $1.20 × 1.15 = $1.38
Since, dividends will increase at a rate of 5% per year indefinitely, Year 3 dividend can be calculated as follows:
Year 3 dividend = Year 3 dividend × (1 + expected increase in dividends in three years)
Year 3 dividend = $1.38 × (1 + 0.05) = $1.38 × 1.05 = $1.449
To now calculate the price of the stock, we use the formula for the dividend discount model stated as follows:
P = Year 3 dividend ÷ (r - g) ................................ (1)
Where,
P = stock price = ?
r = required return = 20% = 0.20
g = growth rate = 5% = 0.05
Substituting the values into equation (1), we have:
P = 1.449 ÷ (0.20 - 0.05) = 1.449 ÷ 0.15 = $9.66
Therefore, the price of the stock is $9.66.
