A stock is expected to pay dividends of $1.20 per share in Year 1 and $1.35 per share in Year 2. After that, the dividend is expected to increase by 2.5% annually. What is the current value of the stock at a discount rate of 14.5%

$10.8734

Explanation:

The computation of the current value of the stock is shown below:

D1 = $1.20

D2 = $1.35

D3 = 1.35 × 1.025 = 1.38375

g = 2.5% = 0.025

Now as we know that

P2 = D3 ÷ (r - g)

where,

Price in year 2 = P2 = $1.38375 ÷ (0.145 - 0.025)

= $11.53125  

So Current Price is

= $1.20 ÷ 1.145 + $1.35 ÷ 1.145^2 + $11.53125 ÷ 1.145^2

= $10.8734

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