P0 = D1/(1 + r) + D2/(1 + r)^2 + D3/(1 + r)^3 + P3/(1 +r)^3
where P3 = D4 / (r - g) < Gordon growth model
D3 = 0.25(1.01) = 0.2525
D4 = 0.2525(1.01) = 0.25503
P3 = 0.25503/(0.125 - 0.01) = 2.21761
P0 = 0.25/1.125 + 0.25/1.125^2 + 0.2525/1.125^3 + 2.21761/1.125^3
{notice that although P3 is based on D4, you only discount P3 by 3! years. IN year 3 you receive D3 + P3.}
combining the year 3 cash flows...
= 0.25/1.125 + 0.25/1.125^2 + 2.47011/1.125^3
= $2.15459
Edit: I could have shortened this up. My bad.
P2 = D3 / (r - g)
P2 = 0.2525 / 0.115 = 2.19565
CF2 = 2.19565 + 0.25 = 2.44565
P0 = 0.25/1.125 + 2.44565/1.125^2
= 0.22222 + 1.93237
= $2.15459
A company announced that next year and the year after, dividends will be $0.25. From then on, it is expected that the dividends grow at a rate of 1%. Investors expect a return of 12.5% from the company. What would be the fair price of this firm?
So I did:
g=0.01, r=0.125
.25(1.01)/(.125-.01)=$2.19565<--but this answer is wrong, why?
