Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2622487 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $15 per share 10 years from today and will increase the dividend by 5 percent per year thereafter.
If the required return on this stock is 14 percent, what is the current share price?
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $15 per share 10 years from today and will increase the dividend by 5 percent per year thereafter.
Explanation / Answer
From DDM P = D(0)*(1+g)/(r-g)
Price of share is Present Value of expected future cash flows from it
P(10) = [ D(10)*(1+g)/(r-g) ] = [ 15*(1+0.05)/(0.14-0.05) ] = $175
P(0) = PV(P(10) + D(10)) = ( 175 + 15 )/1.14^10 = $51.25