Assume that the average firm in your company\'s industry is expected to grow at
ID: 2612419 • Letter: A
Question
Assume that the average firm in your company's industry is expected to grow at a constant rate of 5% and that its dividend yield is 6%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $2.5. You expect that the growth rate of dividends will be 50% during the first year(g0,1 = 50%) and 20% during the second year (g1,2 = 20%). After Year 2, dividend growth will be constant at 5%. What is the required rate of return on your company's stock? Round your answer to two decimal places.
What is the estimated value per share of your firm's stock? Round your answer to the nearest cent. Do not round your intermediate computations.
Explanation / Answer
- Since the company belongs to the same risk group as of the industry thus an investor will require same growth rate and earning yield from the company.
Dividend yield = Dividend/Market Price
Thus, market price(P0) = 2.5/6% = $41.67
D1 = 2.5 x 105% = $2.63
Required rate of return = (D1/P0) + g = (2.63/41.67) + 0.05 = 11.31%
- D1 = 2.5 x 150% = $3.75
D2 = 3.75 x 120% = $4.50
D2 x 105% = $4.73
Estimated value of stock = (3.75/1.11311) + (4.50/1.11312) + [4.73/(0.1131-0.05) x 1/1.11313] = $61.35