Assume that the average firm in your company\'s industry is expected to grow at
ID: 2633118 • 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
Required return = 5% + 7% = 12%
D0 = 1.75
D1 = 1.75 * 1.50 = 2.625
D2 = 2.625 * 1.20 = 3.15
D3 = 3.15 * 1.05 = 3.3075
P3 = D3 / (required return - growth rate) = 3.3075 / (12% - 5%) = 47.25
Price = D1 / (1+return) + D2 / (1+return)^2 + P2 / (1+return)^2
So Price = 2.625 / 1.12 + 3.15 / 1.12^2 + 47.25 / 1.12^2 = 42.52
Answer: Stock price = $ 42.52
Hope this helped ! Let me know in case of any queries.