Chapter 9, Problem 16P

### Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Chapter
Section

### Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

# NONCONSTANT GROWTH Milts Cosmetics Co.’s stock price is $58.88, and it recently paid a$2.00 dividend. This dividend is expected to grow by 25% (or the next 3 years, then grow forever at a constant rate, g; and rs = 12%. At what constant rate is the stock expected to grow after Year 3?

Summary Introduction

To determine: The constant rate that stocks are expected to grow after 3 years.

Horizon Value

It is the present value of all cash inflows and outflows likely to occur at future date with g constant growth rate after that date. The time period up to which company has non-constant growth rate is known as horizon date.

Explanation

Given,

Non constant growth rate for 3 years is 25%.

Dividend paid is $2. Current stock price is$58.88

The formula to calculate present value is:

P0=D1(1+rs)+D2(1+rs)2+D3(1+rs)3+D3(1+gn)rsg(1+rs)4=D1(1+rs)+D1(1+gs)(1+rs)22+D1(1+gs)3(1+rs)3+D1(1+gs)3(1+gn)rsgn(1+rs)3

Substitute $58.88 for P0, 0.25 for gs$2 for D1 and 0.12 for rs in above formula.

$58.88=$2(1+0.25)(1+0

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