Assume that the average firm in your companys industry is expected to grow at a
ID: 2779192 • Letter: A
Question
Assume that the average firm in your companys industry is expected to grow at a constant rate of 6% and that its dividend yeild 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) = D 0 (1.50) this year and 25% the following year, after which growth shouold return to the 6% industry average. If the last dividend paid (D0) was $1, what is the estimated value per share of your firms stock.
The answer is $25.03. SHOW ALL DETAILED WORK AND FORMULAS TO SUPPORT ANSWER
Explanation / Answer
To Calculate cost of Equity, we need to calculate Market Price of Share
Market Price of Share = D1/ Dividend Yield
= 1.06/7% = $ 15.14
Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate
= 1.06/15.14 + 6 %
=7 % + 6 % = 13 %
Value per share of Firms Stock
Stage 1 : Super Normal Growth (Period 1 - 50 % ; Period 2 - 25 %)
Stage 2: Normal Growth @ 6 %
Value of Firm = D3/(k - g)
= 1.88 * 1.06/(.13-0.06)
=1.99/.07 = 28.4286
Present Value of Stage 2 = 28.4286/1.13^2 = 22.2637
Value per share of Firm's Stock = Stage 1 + Stage 2
= 2.7958 + 22.2637 =$25.06/ Share
Period Dividend Calculation Amount Present Value Factor @ 13 % Present Value 1 D1 1 * 1.5 1.50 0.8850 1.3274 2 D2 1*1.5*1.25 1.88 0.7831 1.4684 Total 2.7958