Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2794719 • Letter: M
Question
Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $15 per share dividend 10 years from today and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 10.5 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Current share price? $Explanation / Answer
Current share price = Present value of dividend payable in 10th year + Present value of future dividends payable 11th year onwards Present value of dividend payable in 10th year = Dividend payable * Discount factor of 10th year @ 10.5% Present value of dividend payable in 10th year = $15 * 0.368449 = $5.53 Present value at the end of 10th year of future dividends payable 11th year onwards = Dividend payable in 11th Year / (Required return on stock - Dividend Growth rate) Dividend payable in 11th Year = Dividend payable in 10th year * (1+dividend growth rate) = $15 * (1+0.05) = $15.75 Present value at the end of 10th year of future dividends payable 11th year onwards = 15.75 / (0.105 - 0.05) = $286.36 Present value of future dividends payable 11th year onwards = Present value at the end of 10th year of future dividends payable 11th year onwards * Discount factor of 10th year @ 10.5% Present value of future dividends payable 11th year onwards = $286.36 * 0.368449 = $105.51 Current share price = $5.53 + $105.51 = $111.04