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Supernormal Growth Valuation for Stock

A share of stock currently pays a dividend of D0 = $5. The dividend is expected to grow at a 20 percent annually for the next 10 years, then it will grow at a 15 percent rate for 10 more years, and then at a long-run normal growth rate of 10 percent forever. If investors require a 10 percent return on this stock, what is its current price?

Solution Preview

First, you need to find the dividend with the different expected growth rate.
Then, we know that after D20 has been paid, which is at Year 20, the stock becomes a constant growth stock. Therefore, we can use the constant growth formula to find P20, which is the present value of the dividends from year 21 to infinity. We can calculate P20 as follows: -

P20 = D21 where D21 is the dividend year 21
(k - g) k is the required rate of return
g is the growth rate

P20 = 137.74
(0.10 - 0.08)

P20 = ...

Solution Summary

This solution is comprised of a detailed explanation and calculation to find the current stock price.