Assume that the average firm in your company\'s industry is expected to grow at
ID: 2730130 • Letter: A
Question
Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% 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 30% the following year, after which growth should return to the 4% industry average. If the last dividend paid (D0) was $2.75, 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 dividend in year 1 will be 50% more than the current dividend of $2.75, which will be $ 4.125
The dividend for year two will be 25% more than $ 4.125 which will be $5.16
the value at the end of year two will be =5.16(104%)/(10%-4%) =$ 89.44
Note: Required rate of return which has been calculated by adding growth rate of 4% with dividend yield of 6%, it will be 4+6 = 10%
Computatio of present value of casf flows and present value of value at the end of year
=4.125*PVF(10%,1)+5.16*PVF(10%,2)+89.44*PVF(10%,2)
=4.125*0.909+5.16*.826+89.44*0.826
Current market price =$ 81.89