Answer to Question #41649 in Finance for TARA

Question

Suppose that sales and profits of Oly Enterprises are growing at a rate of 30% per year. At the end of 4 years (t4) the growth rate will drop to a steady 5%. Oly recently paid a dividend of $1 per share. If the required return is 20%, what is the value of one Oly share today (t0)?

(Assume dividends grow at the same rate as earnings after year 4.)

Answer 1

The formula for the present value of a stock with constant growth is the estimated dividends to be paid divided by the difference between the required rate of return and the growth rate.

The present value of a stock with constant growth is one of the formulas used in the dividend discount model, specifically relating to stocks that the theory assumes will grow perpetually. The dividend discount model is one method used for valuing stocks based on the present value of future cash flows, or earnings.
P4 = 1/(0.20-0.05) = P(t0) = 1*(1.3/1.2)^4 + (6.67+1)/1.2 = $7.77