Equity Valuation: Concepts and Basic Tools: practice question
Bramfield Foods just paid a dividend of $1.50 per share. Dividends are projected to grow 10% per year for the next two years and 3% per year thereafter. With a required return of 8.0%, the stock's value today is closest to:
- $30.90
- $32.76
- $35.14
Show answer and explanation
Correct answer: C
Working: D1 = 1.65, D2 = 1.815, D3 = 1.815 × 1.03 = 1.86945; V2 = 1.86945/0.05 = 37.389; V0 = 1.65/1.08 + (1.815 + 37.389)/1.08² = $35.14
Explanation: The two-stage model adds the present values of the two high-growth dividends and of the Gordon terminal value measured at the end of Year 2, giving $35.14. The $30.90 answer wrongly applies the 3% mature rate from today, skipping the high-growth stage, and $32.76 discounts the terminal value for three years instead of two, losing one year of value at the Year-2 price.
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