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Bretton, Inc., just paid a dividend of $3.05 on its stock. The growth rate in dividends is expected to be a constant 5 percent per year, indefinitely. Investors require a return of 12 percent on the stock for the first three years, a rate of return of 10 percent for the next three years, and then a return of 8 percent thereafter. What is the current share price for the stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

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hoangkhangpham94

Answer:

The current share price of the stock: $91.12.

Explanation:

Current share price is equal to the total net present value of the following dividend streams:

The first dividend stream from Y1 to Y3 as followed: Y1: 3.05 x 1.05 = 3.2025; Y2 = $3.3626; Y3 = 3.5308 => Present value of the first dividend stream = 3.2025/1.12 + 3.3626/1.12^2 + 3.5308/1.12^3 = $8.0532.

The second dividend stream fro Y4 to Y6 is : Y4 = 3.3326 x 1.05 = 3.4992; Y5 3.4992 x 1.05 = 3.6742; Y6 = 3.6742 x 1.05 = 3.8579 => Present value of the second dividend stream = 3.4992/1.1^4 + 3.6742/1.1^5 + 3.8579/1.1^6 = $6.8491.

The last dividend stream Y7: 4.0508 and grow 5% each year to the indefinite => Present value is [4.0508/(8% - 5%)]/1.1^6 = $76.219.

=> Current share price = 76.219 + 6.8491 + 8.0532 = $91.12 ( round to two decimal places).

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