Assume that the average firm in your company\'s industry is expected to grow at
ID: 2625983 • 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 7%. 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 20% the following year, after which growth should return to the 5% industry average. If the last dividend paid (D0) was $1.75, 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
D1 = D0(1 + g) = 1.75*1.50 = 2.625
D2 = D1(1 + g) = 2.625*1.20 = 3.15
D3 = D2(1 + g) = 3.15*1.05 = 3.3075
Ke (cost of Equity) = Dividend Yield + Growth rate = 7+5 = 12%
g (Growth rate) = 5%
Value per share of your firm's stock = D1/(1+Ke) + D2/(1+Ke)^2 + (D3/(Ke-g))/(1+Ke)^2
Value per share of your firm's stock = 2.625/(1.12) + 3.15/1.12^2 + (3.3075/(0.12-0.05))/1.12^2
Value per share of your firm's stock = $ 42.52