New Gadgets, Inc., currently pays no dividend but is expected to pay its first annual dividend of $5.40 per share exactly 5 years from today. After that, the dividends are expected to grow at 3.7 percent forever. If the required return is 12.3 percent, what is the price of the stock today

$35.16

Explanation:

Dividend Valuation method is used to value the stock price of a company based on the dividend paid, its growth rate and rate of return. The price is calculated by calculating present value of future dividend payment.

First we will calculate the value of stock after 5 years.

Value of stock = Dividend / (Rate of return - Growth rate)

Value of stock = $5.40 / ( 12.3 % - 3.7 % )

Value of stock = $62.79

As we know the value of the share is the present value of future cash flows associated with the stock. $62.79 is value of the share after 5 years. We have to discount it further to calculate today's value.

Today value of stock = Value after 5 year x Discount factor for 5 years

Today value of stock = $62.79 x ( 1 + 12.3% )^-5 = $35.16

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