solution

(b) Consider a stock that pays annual dividends. The next dividend is expected to be paid in one year and is expected to be $1.0 per share. The annual dividends are expected to be constant for the next five years. After five years, the dividends are expected to be constant at $2.0 per share for the next five years. After ten years, the dividends are expected to grow at the terminal growth rate of 0.5% forever. Note that the stock will pay $1.0 per share dividends in years 1, 2, 3, 4, and 5. The stock will pay $2.0 per share dividends in years 6, 7, 8, 9, and 10. After year 10, the dividends will be higher than the previous year’s dividend by 0.5%. The effective annual cost-of-capital is 14.5%. (1) (ii) Find the fair value of the stock today. Suppose that an analyst thinks that the fair value of the stock should be $11.41 per share. The analyst agrees with the estimates of the dividends for the next 10 years as mentioned above but differs in the value used for the terminal growth rate. What is the terminal growth rate the analyst is using? Since the growth rate is a fraction, please report the final answer with four decimal places so that it will have two decimal places when expressed in percentage.