Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 28 percent for the next three years, with the growth rate falling off to a constant 6.4 percent thereafter. If the required return is 16 percent and the company just paid a dividend of $2.95, what is the current share price

Question

Renee Castaneda

Business

6 March, 08:40

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 28 percent for the next three years, with the growth rate falling off to a constant 6.4 percent thereafter. If the required return is 16 percent and the company just paid a dividend of $2.95, what is the current share price

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Joseph · Answer 1

The current share price is $54.74.

Explanation:

The current share price is the present value of the Year 3 share price plus the present value of the first three dividends.

We first find the Year 3 share price, when the dividend growth becomes constant, using the formula:

P₃ = D₀ (1 + g₁) ³ (1 + g₂) / (R - g₂)

P₃ = 2.95 (1 + 0.28) ³ (1 + 0.064) / (0.16 - 0.064)

P₃ = 6.5825 / 0.096

P₃ = 68.568

Next, we find the present of the dividends received in the first three years plus the present value of the Year 3 stock price calculated above.

P₀ = [2.95 (1.28) / 1.16] + [2.95 (1.28) ² / (1.16) ²] + [2.95 (1.28) ³ / (1.16) ³] + [68.568 / (1.16) ³]

P₀ = $54.74