Answer:
$60.45
Explanation:
Recall that
Po = D1/r - g
Where
Po = current price of stock
D1 = net dividend expected
r = required return
g = constant growth rate
From the question, we are going to pay at super normal growth rate for 3 years followed by constant dividend policy. The value after three years can be calculated by using constant dividend growth formula and after that, present value will be calculated. Thus, current value of stock will be
= D1/(1 + r) + D2(1 + r)^2 + D3/(1 + r)^3 + D4/(r - g)(1 + r)^3
= 2.5 × 1.25/(1 + 13) + 2.5 × 1.25^2/(1 + 13)^2 + 2.5 × 1.25^3(1 + 13)^3 + 2.5 × 1.25 × 1.06/(13 - 6)(1 + 13)^3
= 2.77 + 3.06 + 3.38 + 51.24 = 60.45
Therefore, present value of stock is $60.45
