4.
Using the constant growth model, we find the price of the stock today is:
P
0
= D
1
/ (
R
–
g
)
P
0
= $3.85 / (.12 – .0475)
P
0
= $53.10
10.
We need to find the growth rate of dividends. Using the constant growth model, we can
solve the equation for
g
. Doing so, we find:
g
=
R
– (D
1
/ P
0
)
g
= .12 – ($3.15 / $53)
g
= .0606 or 6.06%
15.
With supernormal dividends, we find the price of the stock when the dividends level off at a
constant growth rate, and then find the present value of the future stock price, plus the
present value of all dividends during the supernormal growth period. The stock begins
constant growth after the fourth dividend is paid, so we can find the price of the stock at
Year 4, when the constant dividend growth begins, as:
P
4
= D
4
(1 +
g
) / (
R
–
g
)
P
4
= $2.80(1.05) / (.11 – .05)
P
4
= $49.00
The price of the stock today is the present value of the first four dividends, plus the present
value of the Year 4 stock price. So, the price of the stock today will be:
P
0
= $5.00 / 1.11 + $16.00 / 1.11
2
+ $21.00 / 1.11
3
+ $2.80 / 1.11
4
+ $49.00 / 1.11
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 Winter '11
 Debruinne
 Finance, constant growth

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