An investor has gathered the following data for a common stock.
Earnings per share, 2013 | $2.50 |
Dividend payout ratio, 2013 | 60% |
Dividend growth rate expected during 2014 and 2015 | 25% |
Dividend growth rate expected after 2015 | 5% |
Investors’ required rate of return | 12% |
Using the two-stage dividend discount model, the value per share of this common stock is closest to:
a. $38.70.
b. $31.57.
c. $28.57.
Is the answer Option B?
First find out dividend for 2013:
EPS = 2.5 and payout ratio = 60%.  Therefore dividend for 2013 = 2.5 * 60% = 1.5(this is D0)
Now, growth rate for 2014 and 2015 is 25%
So, D1 = 1.5 * 1.25 = 1.8750
D2 = 1.8750 * 1.25 = 2.3438
The company is stabilising after 2015 i.e. growth rate = 5%. So we will find P2 and add it to D2.
P2 = D3 / re – g
D3 = 2.3438(1.05) / 0.12 – 0.05 = 35.1563
Now, we will add it to D2 i.e. 35.1563 + 2.3438 = 37.5 (approx)
So, our CF1 = 1.8750Â Â CF2 = 37.5Â Â Â I = 12%
Solve for NPV = 31.57. Option B.