stock valuation II Company XYZ pays no dividends for the next seven years. In ye
ID: 1091925 • Letter: S
Question
stock valuation II
Company XYZ pays no dividends for the next seven years. In year 8, the dividend
is expected to be D8 = $20, and in subsequent years, annual dividend growth will be
G = 4%. The discount rate is R = 6%.
(a) What is the price of a share of XYZ in year 7 (i.e., what is P7)?
(b) What is the price of a share of XYZ today (i.e., what is P0)?
(c) Now let's consider the growth of XYZ's price per share. What is the annual
growth rate of XYZ's price during the time between today and year 7? (Note:
you can answer this directly, or by computing P1 and comparing it to P0.) Is it
smaller, larger or equal to the discount rate? Why?
2
(d) What is the annual growth rate of XYZ's stock price in the years after year 7?
(As above, you can answer this directly, or by comparing P8 and P7.) Is it smaller,
larger or equal to the discount rate? Why?
(e) Would an investor buying a share of XYZ earn a higher annual
Explanation / Answer
a)
price P7 = 20/(6%-4%)= 1000
b) price po = 1000/1.06^7 = 665.06
c) price P1 = 1000/1.06^6 = 704.96
growth rate of price = 704.96 - 665.06 /665.06 = 0.06 = 6%
it is equal to discount rate
d)
p8 = 20*1.04/0.02 = 1040
annual grwth rate of xyz price = 1040 -1000/1000 = 4%
smaller than discount rate
e)
yes
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