Global Tek is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 16 percent a year for the next four years and then the growth slows down to a rate of 3.5 percent per year indefinitely. The company just paid its annual dividend in the amount of $0.20 per share. What is the current value of one share of this stock if the required rate of return is 15.5%?

The value of the stock is $2.558

Explanation:

We need to calculate the present value of future cash flows to calculate the Stock value

First Calculate each year's Dividend

Use the following formula to calculate the expected dividend

Expected Dividend = Current Dividend x ( 1 + Growth rate )^n

Year Working Dividend

1 $0.20 x ( 1 + 16% )^1 $0.232

2 $0.20 x ( 1 + 16% )^2 $0.269

3 $0.20 x ( 1 + 16% )^3 $0.312

4 $0.20 x ( 1 + 16% )^4 $0.362

5$0.362 x ( 1 + 3.5% ) $0.375

Now calculate the present value of each year's dividend using following formula

PV = Dividend / ( 1 + required rate of return )^numbers of years

Year Working PRESENT VALUES

1 $0.232 / ( 1 + 15.5% )^1 $0.201

2 $0.269 / ( 1 + 15.5% )^2 $0.202

3 $0.312 / ( 1 + 15.5% )^3 $0.203

4 $0.362 / ( 1 + 15.5% )^4 $0.203

5$0.375 / (15.5% - 3.5% ) ) / ( 1 + 15.5% ) __$1.749

Now calculate the sum of present value of all the dividends

Value of stock = $0.201 + $0.202 + $0.203 + $0.203 + $1.755

Value of stock = $2.558