Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2627990 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 7 years because the firm needs to plow back its earnings to fuel growth. The company will pay a $11 per share dividend in 8 years and will increase the dividend by 7 percent per year thereafter. NOTE: This is a growing perpetuity where the cash flows start in 8 years. Required: If the required return on this stock is 10 percent, what is the current share price? (Do not round your intermediate calculations.) HINT: the present value equations for an annuity and perpetuity give the value ONE period before the cash flows start, so you will need to discount an additional 7 years.
Explanation / Answer
Value of cash flow of dividend in year 7 = 11/(10%-7%)= 366.67
Current stock price = 366.67/1.1^7= $188.16