Assume that the average firm in your company\'s industry is expected to grow at
ID: 2701175 • Letter: A
Question
Assume that the average firm in your company's industry is expected to grow at a constant rate of 7% and that its dividend yield is 6%. 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 7% industry average. If the last dividend paid (D0) was $3, 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
assuming that the current dividend yield (7%) remains the required rate of return...
Value = PV of next yrs div + PV of 2nd yr div. + PV of perpituity from the perspective of the end of year 2...using the Gordon growth model.
Value = 1.50/1.07^1 + 1.50(1.25)/1.07^2 + [1.50(1.25)(1.06) / (0.07 -0.06)] / 1.07^2