Question #17
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 7
Status: Correct
Correct Answer: A
Question
JAD just paid a dividend of $0.80. Analysts expect dividends to grow at 25% in the next two years, 15% in years three and four, and 8% for year five and after. The market required rate of return is 10%, and Treasury bills are yielding 4%. JAD has a beta of 1.4. The estimated current price of JAD is closest to:
Answer Choices:
A. $25.42
B. $45.91
C. $29.34
Explanation
JAD's stock price today can be calculated using the three-stage model. Start by finding the
value of the dividends for the next four years with the two different dividend growth rates.
D1 = D0(1+g) = $0.80(1.25) = $1.00
D2 = D1(1+g) = $1.00(1.25) = $1.25
D3 = D2(1+g) = $1.25(1.15) = $1.4375
D4 = D3(1+g) = $1.4375(1.15) = $1.6531
(Alternatively, you could use your financial calculators to solve for the future value to find
D1, D2, D3, and D4.)
Next find the value of the stock at the beginning of the constant growth period using the
constant dividend discount model:
The easiest way to proceed is to use the NPV function in the financial calculator.
CF0 = 0; CF1 = 1.00; CF2 = 1.25; CF3 = 1.4375; CF4 = 1.6531 + 40.57 = 42.22
I = 12.4; NPV = 29.34
The value of the firm today is $29.34 per share.