Info

$1

$2

$2.50

$2.50 X 1.05

$2.50 X 1.052

P3 = D3 X (1 + g)/(R - g) = $2.50 X 1.05/(.10 - .05) = $52.50

We can now calculate the total value of the stock as the present value of the first three dividends plus the present value of the price at Time 3, P3:

D1 D2 D3 P3

^L .250 52.50 = 1.10 + 1.102 + 1.103 + 1.103 = $.91 + 1.65 + 1.88 + 39.44 = $43.88

The value of the stock today is thus $43.88.

Supernormal Growth

Chain Reaction, Inc., has been growing at a phenomenal rate of 30 percent per year because of its rapid expansion and explosive sales. You believe that this growth rate will last for three more years and that the rate will then drop to 10 percent per year. If the growth rate then remains at 10 percent indefinitely, what is the total value of the stock? Total dividends just paid were $5 million, and the required return is 20 percent.

Chain Reaction's situation is an example of supernormal growth. It is unlikely that a 30 percent growth rate can be sustained for any extended length of time. To value the equity in this company, we first need to calculate the total dividends over the supernormal growth period:

Year

Total Dividends (in millions)

0 0

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