Question

The Commons Company's last dividend ((D)) was $1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Commons' required return ((r)) is 10%. What is Commons' current stock price ((P_0))?

a) $41.12
b) $37.69
c) $35.05
d) $32.20

Answer 1

To calculate the current stock price of The Commons Company, we use the dividend discount model (DDM). The stock price is determined by the expected future dividends and the required return rate. By plugging in the given values and using the DDM formula, we find that the current stock price is approximately $38.00.

Step-by-step explanation:

To calculate the current stock price (P0) of The Commons Company, we need to use the dividend discount model (DDM). The DDM formula is P0 = D1 / (r - g), where D1 is the next year's expected dividend, r is the required return, and g is the constant dividend growth rate.

First, we calculate D1 by multiplying the last dividend (D) by (1 + g) for each year.

In this case, D = $1.00, g = 15%, and we have 2 years of constant growth rate, so D1 = $1.00 * (1 + 0.15) * (1 + 0.15) = $1.52.

Next, we substitute the values into the DDM formula: P0 = $1.52 / (0.10 - 0.06) = $38.00.

Therefore, the current stock price (P0) for The Commons Company is approximately $38.00.