Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2728419 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $12 per share dividend 10 years from today and will increase the dividend by 6 percent per year thereafter. If the required return on this stock is 11 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current share price $
Explanation / Answer
Here,We have given a stock that paid no dividend for 9 years ,once the stock paying dividends ,it will have a consstant growth rate of dividends .We can use constant growth model at that point . The formula for Constant Growth mdel is, Pt = [Dt × (1 + g)] / (R – g) It means that since we will use the dividend in Year 10, we will be finding the stock price in Year 9. The dividend growth model is similar to the PVA and the PV of a perpetuity: The equation gives us the PV one period before the first payment. So, the price of the stock in Year 9 will be: P9 = D10 / (R – g) = $12.00 / (.11 – .06) = $ 240 The price of the stock today is simply the PV of the stock price in the future. So We need to discount the future stock price at the required return. The price of the stock today will be: (Price of the Stock in year 10) / (1 + r)^10 =240/(1+0.11)^10 =240/2.8394 =$84.52 So Current Share Price is $ 84.52