Consider the situation for Hampton Inc., a company that was set up in 2015 to pr
ID: 2731586 • Letter: C
Question
Consider the situation for Hampton Inc., a company that was set up in 2015 to produce and market a new high-tech fishing lure. Hampton’s sales are currently growing at a rate of 100% per year. The company expects to experience a high but declining rate of growth in sales and earnings during the next 10 years, after which analysts estimate that it will grow at a steady 10% per year. The firm’s management has announced that it will pay no dividends for 5 years (2016 to 2020) but that if earnings materialize as forecasted, it will pay a dividend of $0.40 per share at the end of Year 6 (in 2021), $0.60 in Year 7, $0.80 in Year 8, $1 in Year 9, and $1.20 in Year 10. After Year 10, current plans are to increase dividends by 5.5% per year. Hampton’s investment bankers estimate that investors require a 9.75% return on similar stocks.
1) What is the Hampton’s stock price at the end of 10th year?
2) What is the Hampton’s stock current price based on the dividend discount model?
Explanation / Answer
Part 1)
The stock price at the end of 10th Year is calculated as follows:
Stock Price = Dividend for Year 10*(1+Growth Rate)/(Required Return-Growth Rate)
Using the information provided in the question, we get,
Stock Price at the End of Year 10 = 1.20*(1+5.5%)/(9.75% - 5.5%) = $29.79
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Part 2)
The current stock price can be calculated with the use of following formula:
Current Stock Price = Dividend Year 6/(1+Required Return)^6 + Dividend Year 7/(1+Required Return)^7 + Dividend Year 8/(1+Required Return)^8 + Dividend Year 9/(1+Required Return)^9 + Dividend Year 10/(1+Required Return)^10 + Price at Year 10/(1+Required Return)^10
Using the price calculated in Part 1 an information provided in the question, we get,
Current Stock Price = .40/(1+9.75%)^6 + .60/(1+9.75%)^7 + .80/(1+9.75%)^8 + 1/(1+9.75%)^9 + 1.20/(1+9.75%)^10 + 29.79/(1+9.75%)^10 = $13.58