CX Enterprises has the following expected dividends: $ 1.00 in one year, $ 1.15 in two years, and $ 1.25 in three years. After that, its dividends are expected to grow at 4 % per year forever (so that year 4's dividend will be 4 % more than $ 1.25 and so on). If CX's equity cost of capital is 12 %, what is the current price of its stock?

$14.27

Explanation:

The current price of the stock is the present value of dividends payments for the first three years and terminal value , which is the  value of the company after three years.

Present value of year 1 dividend=$1/(1+12%)^1=$0.89  

Present value of year 2 dividend=$1.15/(1+12%)^2=$0.92  

Present value of year 3 dividend=$1.25/(1+12%)^3=$0.89  

Terminal value=year 3 dividend*(1+g)/(r-g)

g is the dividend growth after year 3 which is 4%

r is the equity cost of capital of 12%

terminal value=$1.25*(1+4%)/(12%-4%)=$16.25

Present value of terminal value=$16.25 /(1+12%)^3=$11.57  

Stock price=sum of present values=$0.89+$0.92+$0.89+$11.57=$14.27

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