Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2780909 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next eight years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $15.25 per share 9 years from today and will increase the dividend by 5.75 percent per year thereafter. Required: If the required return on this stock is 13.75 percent, what is the current share price? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Explanation / Answer
Present Value of Dividends=D1/(1+r)+D2/(1+r)^2+D3/(1+r)^4..............
Here, D1=D2=...D8=0
D9=15.25, D10=D9*1.0575,D11=D10*1.0575.............
r=13.75%
Hence, PV of dividends=15.25/1.1375^9+15.25*1.0575/1.1375^10.............
=15.25/1.1375^9/(1-1.0575/1.1375)
=68.009
Alternatively, using Dividend Discount Model (Gorden Growth Model), we know Price at the end of 8 years will be D9/(r-g)=15.25/(0.1375-0.0575)=190.625
So, Price today=Price8/(1+r)^8=190.625/1.1375^8=68.009
So, current share price=$68