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A junior growth company has just paid a dividend of $1 (i.e. D0 =1), and dividends are expected to grow at 14% per year over the next five years (t =1,…,5). The required rate of return on the stock is 9%, and stock price is anticipated to be $100 in five years (i.e. P5 =100).
a. Derive the current price of the stock (i.e. P0) consistent with present value pricing. After the five year growth phase, dividends are expected to grow at a slower but constant rate g’ forever (i.e. for t > 5). As the company will be safer after the growth phase, the required rate of return drops to 7%.
b. Find the growth rate of dividends g’ < .08 .09 that is consistent with the given price P5 = 100.
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