Problem: Surgical Supplies Corp. paid a dividend of $1.12 over the last 12 months. The dividend is expected to grow at a rate of 25% over the next 3 years (supernormal growth). It will then grow at a normal, constant rate of 7% for the foreseeable future. The required rate of return is 12% (this will also serve as the discount rate).
1) Compute the anticipated value of the dividends for the next 3 years (D1, D2, and D3).
2) Discount each of these dividends back to the present at a discount rate of 12% and then sum them.
3) Compute the price of the stock at the end of the third year (P3): P3=D4/Ke - g
4) After you have computed P3, discount it back to the present at a discount rate of 12% for 3 years.
5) Add together the answers in part b and part d to get the current value of the stock. (This answer represents the present value of the first three periods of dividends plus the present value of the price of the stock after three periods.)