Garcia Inc. has a current dividend of $3.00 per share (D0 = $3.00). Analysts expect the dividend to grow at a rate of 25% for the next three years, and at a constant rate of 10%, thereafter. The company's cost of equity is estimated to be 15%. What is Garcia's current stock price?

a. $110.00
b. $103.25
c. $ 95.42
d. $ 88.55
e. $ 75.00

The current price of the stock is $95.42 and option C is the correct answer.

Explanation:

The current price of the stock of Gracia can be calculated using the two stage Gordon Growth model also known as the two stage dividend discount model. The formula for the current price of the stock under the two stage growth model for this stock is,

P0 = D0 * (1+g1) / (1+r)  +  D0 * (1+g1)^2  /  (1+r)^2  +  D0 * (1+g1)^3  /  (1+r)^3  +  

[( D0 * (1+g1)^3 * (1+g2)  /  (r - g2))  /  (1+r)^3 ]

P0 = 3 * (1+0.25)  /  (1+0.15)  +  3 * (1+0.25)^2  /  (1+0.15)^2  +  

3 * (1+0.25)^3  /  (1+0.15)^3  +  [( 3 * (1+0.25)^3 * (1+0.1) / (0.15-0.1)) / (1+0.15)^3]

P0 = $95.415 rounded off to $95.42

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