A company currently pays a dividend of $2.2 per share (D0 = $2.2). It is estimated that the company's dividend will grow at a rate of 18% per year for the next 2 years, and then at a constant rate of 8% thereafter. The company's stock has a beta of 1.4, the risk-free rate is 8%, and the market risk premium is 3.5%. What is your estimate of the stock's current price? Do not round intermediate calculations. Round your answer to the nearest cent.

P0 = $57.6722 rounded off to $57.67

Explanation:

To calculate the market price of the stock today, we will use the two stage growth model of DDM. The two stage growth model calculates the values of the stock today 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,

We first need to calculate r using the CAPM equation. The equation is,

r = rRF + Beta * rpM

Where,

r = 0.08 + 1.4 * 0.035

r = 0.129 or 12.9%

Using the price formula for DDM above, we can calculate the price today to be,

P0 = 2.2 * (1+0.18) / (1+0.129)  +  2.2 * (1+0.18)^2 / (1+0.129)^2  +  

[(2.2 * (1+0.18)^2 * (1+0.08)) / (0.129 - 0.08)] / (1+0.129)^2

P0 = $57.6722 rounded off to $57.67

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explanation:

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