Assume that the average firm in your company\'s industry is expected to grow at
ID: 2722566 • 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 25% the following year, after which growth should return to the 5% 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
The Required Rate of Return in the industry is 12%, i.e. 7% Div Yield + 5% Constant Growth
Your company - Next Div at T1 = 1.50, at T2 = 1.88, at T3 = 1.99
PV of 1.50, N 1, R 12% = 1.34
PV of 1.88, N 2, R 12% = 3.18
Price at T2 = Next Div 1.99 / 12% - 5% = 28.43
PV of 28.43, N 2, R 12% = 22.66
Stock Price today = 1.33 + 1.47 + 22.66 = 25.46