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14 March, 18:21

NewTech Incorporated management plans on paying the company's first dividend of $2.00 three years from today (D3 = $2.00) on its' common stock. After year three the dividend is expected to grow at a constant rate of 5% thereafter. As an investor with a required rate of return of 15%, what would you pay for NewTech common stock today?

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  1. 14 March, 21:17
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    Stock price today = $13.807

    Explanation:

    According to the dividend valuation model, the current price of a stock is the present value of the expected future dividends discounted at the required rate of return

    This principle can be applied as follows:

    The value of cash flow the stock today is the present value of the future cash flow discounted at the required rate of return

    Step 1 : Compute the PV in year 3 of future dividend

    PV = D * (1+g) / r-g

    D - div in year 3, g - growth rate, r-required rate of return

    PV in year 3 = 2 * (1.05) / 0.15-0.05

    = 21

    Step 2: PV in year in year 0

    PV = PV in year 3 * (1+r) ^ (-n)

    r-rate of return - 15%, n - number of years - 3

    = 21 * 1.15^ (-3)

    =13.80784088

    Stock price today = $13.807
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