Problem 7-12 Nonconstant Growth Stock Valuation Assume that the average firm in
ID: 2622091 • Letter: P
Question
Problem 7-12
Nonconstant Growth Stock Valuation
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 8%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 30% the following year, after which growth should return to the 5% industry average. If the last dividend paid (D0) was $2, what is the value per share of your firm's stock? Round your answer to the nearest cent. Do not round your intermediate computations.
$
Explanation / Answer
Nonconstant Growth Stock Valuation
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 8%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 30% the following year, after which growth should return to the 5% industry average. If the last dividend paid (D0) was $2, what is the value per share of your firm's stock? Round your answer to the nearest cent. Do not round your intermediate computations.
value per share of your firm's stock = 2*1.50/1.08 + 2*1.50*1.30/1.08^2 + (2*1.50*1.30*1.05/(0.08-0.05))/1.08^2
value per share of your firm's stock = $ 123.15
Answer:
$ 123.15