XYZ Inc. is planning on increasing its annual dividend by 10 percent a year for the next 4 years and then decreasing the growth rate to 5 percent per year. The company just paid its annual dividend in the amount of $0.20 per share. What is the current value of one share of this stock if the required rate of return is 15 percent

The current value of this stock is $2.74

Explanation:

The two stage growth model of Dividend discount model approach will be used to calculate the price of the stock today. This model bases the price of the stock on the expected future dividend payments from the stock. The price per share of such a stock will be calculated as follows,

Taking the 10% growth as g1.

Taking the constant growth of 5% as g2.

P0 = 0.2 * (1+0.1) / (1+0.15) + 0.2 * (1+0.1) ^2 / * 1+0.15) ^2 +

0.2 * (1+0.1) ^3 / (1+0.15) ^3 + 0.2 * (1+0.1) ^4 / (1+0.15) ^4 +

[ (0.2 * (1+0.1) ^4 * (1+0.05) / (0.15 - 0.05)) / (1+0.15) ^4 ]

P0 = $2.474 rounded off to $2.47