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? a. $41.58. b. $42.64.

c. $43.71. d. $44.80. e. $45.92.

option b is correct

current stock price is $42.64

Explanation:

given data

dividend = $1.75

growth rate = 25% for 2 year

growth rate 1 = 6%

required return 2 = 12%

to find out

current stock price

solution

we will find here first stock price after 2 year that is

stock price = cash flow at 2 year end * (1+rate) / (rate 2 - rate1) ... 1

so here cash flow at 2 year end = 1.75*1.25 = 2.1875

2.1875 * 1.25 = 2.734

stock price = 2.734 * (1 + 0.06) / (0.12 - 0.06)

stock price = 48.30

so stock price at 0.12 return

= cash flow at 1 year / (1 + rate 2) + cash flow at 2 year / (1 + rate 2) ² + stock price / (1 + rate 2) ²

= 2.1875 / (1 + 0.12) + 2.734 / (1 + 0.12) ² + 48.30 / (1 + 0.12) ²

= $42.64

so option b is correct

current stock price is $42.64