Dixie Construction is a young firm that is in the process of bidding (and winnin
ID: 2653902 • Letter: D
Question
Dixie Construction is a young firm that is in the process of bidding (and winning) construction contracts. While they are unable to pay any dividends today, once the contracts are awarded and their work begins in earnest, they expect to be able to start paying a dividend of $2.00 per share beginning three years from now (t = 3). From that point forward, as they build their reputation and capacity, they expect to be able to increase their dividend 5.00% each year. If Dixie's cost of equity capital is 7.50% (the discount rate for equity), what price per share should their shares trade at today?
Explanation / Answer
Share Price at year 2 = Expected Dividend in year 3 /(Cost of Equity - Growth rate)
Share Price at year 2 = 2/(7.50%-5%)
Share Price at year 2 = $ 80
Share Price today = Share Price at year 2 /(1+cost of equity)^2
Share Price today = 80/1.075^2
Share Price today = $ 69.23