Metallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2804617 • 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 dividend of $15 per share in 10 years and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 14.5 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
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 dividend of $15 per share in 10 years and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 14.5 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Solution:
Using the constant dividend growth formula is:Pt= [Dt×(1 +g)] / (Rg)
Since we will use dividend in year 10, we find the stock price in year 9. So, the price of the stock in Year 9 will be:
P9= D10/ (Rg) = $15.00 / (0.145 0.05) = $157.895
The price of the stock today is simply the PV of the stock price in the future. We simply discount the future stock price at the required return. The price of the stock today will be:
P0= $157.895 / 1.145^9= $46.68