A tech start-up company has just become public. It just paid $3 dividend per share, which will grow 10% for the next two dividends. Afterwards, the dividends will level off and grow at 4% per year forever. If the investors require 6% return on similar investments, what is the price of stock

P0 = $174.3396226 rounded off to $174.34

Explanation:

The two stage growth model of DDM will be used to calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g1) / (1+r)  +  D0 * (1+g1)^2 / (1+r)^2  +  ...  +  D0 * (1+g1)^n / (1+r)^n  +   [(D0 * (1+g1)^n  *  (1+g2) /  (r - g2))  /  (1+r)^n]

Where,

P0 = 3 * (1+0.1) / (1+0.06)  +  3 * (1+0.1)^2 / (1+0.06)^2  +

[(3 * (1+0.1)^2  *  (1+0.04)  / (0.06 - 0.04))  /  (1+0.06)^2]

P0 = $174.3396226 rounded off to $174.34

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