Assume that the average firm in your company\'s industry is expected to grow at
ID: 2631943 • Letter: A
Question
Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 5%. 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 4% industry average. If the last dividend paid (D0) was $2.25, 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
The current dividend paid is $2.25 with growth rate of 50% that becomes $3.375 in year 1. Then the growth rate is 20%, so the dividend in year 2 will be $4.05 *calculated as (3.375*1.20)
Now, we calculate value at the end of two years.
Required rate of return = Growth rate + Dividend yield = 4% + 5% =9%
Value at the end of 2 years = ($4.05*1.04)/9%-4% = $84.24
Present value = $84.24/1.092=$70.90
Present value of Dividend (Year 1) = $3.375/1.09 = $3.09
Present value of Dividend (Year 2) = $4.05/1.092 = $3.40
Adding all the resent value:
Total value per share of firm's stock = $70.90 + $3.09 + $3.40 = $77.40