Please answer the following question from the selections, showing ALL WORK. We w
ID: 2801741 • Letter: P
Question
Please answer the following question from the selections, showing ALL WORK.
We will now consider the same information again. A firm’s total annual dividend payout is $1 million. Its stock price is $45 per share and it has 17,500,000 shares outstanding. The firm earned $4 million in Net Income last year. This year, the firm expects earnings to grow at 7%, with growth the year after that expected to be 5%, and then in all following years, the firm expects earnings to grow at 3%. The firm plans to hold their dividend payout ratio constant over the coming 20 years and beyond. The risk free rate is 3%, beta for the dividend portion of the firm must be lower than for the entire income stream, and it measured at is 0.65, and the equity risk premium is 7.75%. What is the value of equity for the entire firm using the DIVIDEND DISCOUNT model, using annual dividends as free cash flow?
a. 15.5 million
b. 20.2 million
c. 34.3 million
d. 8.7 million
Explanation / Answer
D0= $1000000, D1= 1000000*1.07= $1070000, D2= $1070000*1.05= 1123500, D3= 1123500*1.03= 1157205
Re= Rf+ERP*Beta= 3+(7.75*0.65)= 8.0375%
Growth rate(substantial)= 3%
Value at the end of 2nd year= D3/(Re-g)= 1157205/(0.080375-0.03)= $22971811.41
Using BA II pus calculator to find out the value today:
Go to cash flow mode
CF0=0, CF1= 1070000, CF2= 1123500+22971811.41= 24095311.41 I= 8.0375, NPV CPT
NPV or value of equity=$21633904.45