Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will pro
ID: 2727085 • Letter: S
Question
Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today?
Explanation / Answer
EPSo = 1.10
EPS3 = 1.10 x (1+0.40)^3 = 3.0184
We have following formula for the price of stock three years from now:
P3 = EPS3 x DP ratio x (1+g)/ (R-g)
= 3.0184 x 0.75 x (1+0.05) / (0.12 -0.05)
= 2.37699 / 0.07
= 33.957
Current price would be present value of future price:
PV = FV / (1+r)^3
= 33.957 / (1+0.12) ^3
= 24.17