Assume that the average firm in your company\'s industry is expected to grow at
ID: 2760058 • 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 20% the following year, after which growth should return to the 5% industry average. If the last dividend paid (D0) was $1.75, what is the value per share of your firm's stock?
Explanation / Answer
Answer
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%.
Cost of capital = dividend yield + Growth rate
= 7% + 5%
= 12%
Figures in $
Particulars
Amount
Dividend at end of year 3
a
3.3075
(3.15*1.05)
Cost of capital - Growth rate
b
0.07
(0.12-0.05)
Market price end of year 2 (a/b)
47.25
Figures in $
Year
Dividend
Market price
Cash flow
Disc Rate : 12%
Present value
A
B
C
D
A+B
C*D
1
1.75*1.50
2.625
2.625
0.89
2.34
2
2.625*1.2
3.15
47.25
50.4
0.80
40.18
Net present value
42.52
Answer : The value per share of your firm's stock is $ 42.52
Figures in $
Particulars
Amount
Dividend at end of year 3
a
3.3075
(3.15*1.05)
Cost of capital - Growth rate
b
0.07
(0.12-0.05)
Market price end of year 2 (a/b)
47.25