Mitts cosmetics co.'s stock price is 58.88$, and it recently paid a 2$ dividend. This dividend is expected to grow by 25% for the next 3 years, and then grow forever at a constant rate, g. The required rate of return on the stock is 12%. At what constant rate is the stock expected to grow after year 3?
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Price of Stock = Sum of Present Values of all future dividends expected, Calculate the first three years dividends, discount hem at 12% then add the sum value for the years to infinity.Dividends = D(1)=2.5,D(2)=3.125, D(3)=3.906, afterwards D(i) =3.906*(1+g)^i Dividend Growth Rate=25%,25%,25%,g Required Rate of Return= Discount Rate Used to bring the future value to present value = 12% = 0.12 Discount Factors to bring the future dividends to present - Factor(1)= 1/ (1+0.12)^1=0.8929, F(2)=1/ (1+r)^2=0.7972, F(3)=1/ (1+r)^3=0.7118 D(i)xF(i) =Present Value of Dividends=2.23,2.49,2.78, then D(i) x (1+g)^î D3/(r-g)=3.91/(0.12-g) Price of Stock = Sum of Present Values of all future dividends expected=7.50 + D3/(r-g)=3.91/(0.12-g) For Example: If dividend growth rate contiues as 10% fourth year onwards, Price of Stock = $7.50 +$195.3=$202.80 Read: The Analysis and Use of Financial Statements by White&Sondhi&Fried , J. Wiley Publication , Chapter 19, Page 1044,
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