Question
Assume that it is now january It is now January 1, 2002. Wayne-Martin Electric Inc. (WME) has just developed a solar panel capable of generating 200 percent more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15 percent annual growth rate for the next 5 years. By the end of the 5 years, other firms will have developed comparable technology, and WME's growth rate will slow to 5 percent per year indefinately. Stockholders require a return of 12 percent on WME's stock. The most recent annual dividend (Do), which was paid yesterday, was $1.75 per share.
a. Suppose the annual growth rate will be only 12 percent during the next five years and that the firm's normal growth rate will be only 4 percent. Without doing any calculations, what general effect would these growth rate changes have on the price of WME's stock?
b. Suppose that WME is considered quite risky and that the required rate of return should be higher than the 12 percent originally specified. Rework the problem under the conditions given in part a. except change the required rate of return to (1) 13 percent, (2) 15 percent, and (3) 20 percent to determine the effects of the higher required rates of return on WME's stock price.
Explanation / Answer
a. here we have to observe ,the growth rate has two stages at stage 1 (form 1st year to 5th year) is 12%(g1) stage 2 there after 4%(g2) Apply two stage growth model.. Po = D1*[1-[1+g1 / 1+r]^n / r-g1] + [D1(1+g1)^n-1(1+g2) / (r-g2)] * [ 1 / (1+r)^n] here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.12]^5 / 0.12-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.12-0.04]*[1/(1.12)^5 = 1.995*4.62 +43.797*0.5674 =9.21+24.852 Stock price =$34.07 b.If 1.required rate of return 13% here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.13]^5 / 0.13-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.13-0.04]*[1/(1.13)^5] here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.13]^5 / 0.13-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.13-0.04]*[1/(1.13)^5] here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.13]^5 / 0.13-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.13-0.04]*[1/(1.13)^5] =$30.11 2..required rate of return 15% here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.15]^5 / 0.15-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.15-0.04]*[1/(1.15)^5] =$24.36 here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.15]^5 / 0.15-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.15-0.04]*[1/(1.15)^5] here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.15]^5 / 0.15-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.15-0.04]*[1/(1.15)^5] =$24.36 3.if reuired rate of return 20% here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.2]^5 / 0.2-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.2-0.04]*[1/(1.20)^5] =$16.32 here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.2]^5 / 0.2-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.2-0.04]*[1/(1.20)^5] =$16.32 here d1 = d0*[1+g1] = 1.75*[1.14] =$1.995 Ther fore Po = 1.995*[1-[1+0.14 / 1.2]^5 / 0.2-0.14] + [1.995*(1+0.14)^5-1*(1.04) / 0.2-0.04]*[1/(1.20)^5] =$16.32