For many companies, it is unreasonable to assume that dividends grow at a constant growth rate. Hence, valuation for these companies proves a little more complicated. The valuation process, in this case, requires us to estimate the short-run nonconstant growth rate and use it to predict near-term dividends. Then, we must estimate a constant long-term growth dividend growth rate. Generally, we assume that after a certain point of time, all firms begin to grow at a more-or-less constant rate. Of course, the difficulty in this framework is estimating the short-term growth rate, how long the short-term growth will hold, and then the long-term growth rate.
In general, one should predict as many future annual dividends as possible and then discount them back to the present. Then, all dividends to be received after the end of nonconstant growth (the beginning of constant growth) will be valued using the constant growth model presented above.
A company’s stock just paid a $1.82 dividend, which is expected to grow at 30 percent for the next three years. After three years, the dividend is expected to grow constantly at 10 percent forever. The stock’s required return is 16 percent. What is the price of the stock today?
Last dividend paid$1.82 Required rate of return16% Expected ST growth rate30% Short-run E(g); for Years 1-3 only. Expected LT growth rate10% Long-run E(g); for Year 4 and all following years. 30% 10% Year01234 Dividend$1.82$2.37$3.08$4.00$4.40 $2.04 = PV of Year 1 dividend $2.29 = PV of Year 2 dividend $2.56 = PV of Year 3 dividend $6.89 = sum of dividend PVs 73.31= Terminal value$46.96 = PV of terminal value $53.85 = E(P0)
Now, with this information…how would you explain to a nonhealthcare major why this is important and how this information is beneficial. Be very descriptive!