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Harvey County Choppers, Inc. is experiencing rapid growth. The company expects dividends to grow at 25 percent per year for the next 7 years before leveling off to 7 percent into perpetuity. The required return on the stock is 12 percent. What is the current stock price if the annual dividend share that was just paid was $1.05?

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hoangkhangpham94

Answer:

The current stock price should be at $60.15.

Explanation:

We have the dividend paid next year = 1.05 x 1.25 = $1.3125.

So, the present value of the growing annuity of dividend stream in the next 7 years is calculated as:

[ 1.3125 / (12% - 25%) ] x [ 1 - [ (1+25%)/( 1+12%) ] ^7 ] = $11.68.

The present value of the dividend stream from year 8 to infinity ( growing perpetuity):

[ 1.05 x 1.25^7 x 1.07/ (12% - 7%) ] / 1.12^7 = $48.47.

The price of the stock should be equal to the sum of present value of the two dividend stream above which is 11.68 + 48.47 = $60.15.

Thus, the answer is $60.15 per share.  

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