Biarritz 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 7.9 percent thereafter. If the required return is 16 percent and the company just paid a dividend of $3.70, what is the current share price?

The price of the stock today is $79.78

Explanation:

The two stage growth model of the DDM will be used to calculate the price of the stock based on discounting the expected future dividends. The first three years dividends will be discounted using the required rate of return along with the calculation of terminal value at the end of third year when the dividend growth becomes constant. The terminal value will also be discounted back. The price per share of the stock today is,

P0 = D1 / (1+r)  +  D2 / (1+r)^2  +  D3 / (1+r)^3  +  [D3 * (1+g) / (r - g)] / (1+r)^3

Where,

D1 is the D0 * (1+G) which is and G is the initial growth rate of 28%.

P0 = 3.7 * (1+0.28) / (1+0.16)  +  3.7 * (1+0.28)^2  /  (1+0.16)^2  +  

3.7 * (1+0.28)^3  /  (1+0.16)^3  +  

[ 3.7*(1+0.28)^3*(1+0.079) / (0.16-0.079)] / (1+0.16)^3

P0 = $79.779 rounded off to $79.78