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Estimating price of a common stock

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You are considering the purchase of a common stock that paid a dividend of $1.00 yesterday. You expect this stock to have a growth rate of 20% for the next 3 years, resulting in dividends of:

D1 = $1.20
D2 = $1.44
D3 = 1.73

The long run normal growth rate after year 3 is expected to be 8% (that is,a constant growth rate after year 3 of 8% per year forever). If you require a 12% rate of return, how much should you be willing to pay for this stock?

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Solution Summary

Solution describes the steps for estimating price for common stock.

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Solution:

D1 = $1.20
D2 = $1.44
D3 = $1.73
D4=D3*(1+8%)=1.73*(1.08)= $1.8684
D5=D4*(1+8%)=2.017872
and so ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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