ABC common stock is expected to have extraordinary growth in earnings and dividends of 20% per year for 2 years, after which the growth rate will settle into a constant 6%. If the discount rate is 15% and the most recent dividend was $2.50, what should be the approximate current share price? (Hint: this is Case 3, the non-constant growth

ABC current share price is $33.21.

Here, we are going to calculate the current share priceof ABC using the information in the question.

D1 = Recent dividend * (1 + 20%)

D1 = ($2.5*1.2)

D1 = $3

D2 = Recent dividend * (1 + 20%)

D2 = ($3*1.2)

D2 = $3.6

Value after year 2 = (D2 * Growth rate) / (Discount rate - Growth rate)

Value after year 2 = ($3.6*1.06) / (0.15 - 0.06)

Value after year 2 = $42.4

Current share price = Future dividends*Present value of discounting factor (15%,time period)

Current share price = $3/1.15 + $3.6/(1.15)^2 + $42.4/(1.15)^2

Current share price = $2.61 + $2.72 + $27.88

Current share price = $33.21

Therefore, ABC current share price is $33.21.

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$37.39

Explanation:

The computation of the approximate current share price is shown below:

But for this, first we compute the current value which is shown below:

= Next year dividend ÷ (Required rate of return - growth rate)

where,  

Current year dividend

For one year

= $2.5 + $2.5 × 20%

= $2.5 + 0.05

= $3

For next year

= $3 + $3 × 20%

= $3 + 0.6

= $3.60

For the third year

= $3.60 + $3.60 × 6%

= $3.60 + 0.216

= $3.816

Now the current value is

= ($3.816) ÷ (15% - 6%)

= $42.4

Now the current share price is

= $3 ÷ 1.15 + $3.6 ÷ 1.15^2 + $42.4 ÷ 1.15^2

= $2.61 + $2.72 + $32.06

= $37.39

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