Value of Common Stock

A

To determine the value of a common stock experiencing temporary supernormal growth, use the following equation:

{V = {[d0 * (1 + gs)^1] / k} + {[d1 * (1 + gs)^2} + ... {dn * (1 + gs)^n} + {[dn * (1 + gs)^n * (1 + gn] / (k - g)}/ (1 + k)^n}}

Where: V = the value of common stock at t0, d0 = the dividend at t0, d1 = the dividend at t1, dn = the dividend at tn, gs = the supernormal rate of growth, gn = the normal rate of growth, n = the time period "n", and k = the required rate of return.

In this example, there is a transitional growth period of two years, during which the growth rate of Composite Software is expected to grow at 25% annually. This period will follow the two-year supernormal growth period, and would be denoted as g subset t. The calculation of the value of this common stock is illustrated as follows:

{V = {[$0.80 * (1.30)^1] / (1.175)^1} + {[$0.80 * (1.30)^2] / (1.175)^2} + {[$0.80 * (1.30)^2 * (1.20)^1] / (1.175)^3} + {[$0.80 * (1.30)^2 * (1.20)^2] / (1.175)^4} +

{{[$0.80 * (1.30)^2 * (1.20)^2 * (1.15)^1]/ (0.175 - 0.15)}/ (1.175)^4}

Which can be deduced to the following:

{V = [$0.885106 + $0.979267 + $1.000102 + $1.021381 + $46.98352] = $50.87}