A company is presently enjoying relatively high growth because of a surge in the

Question

A company is presently enjoying relatively high growth because of a surge in the demand for its new product management expects earnings and dividends to grow at a rate of 34% for the next two years 20.85% in year three and four and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6.00% the company's last dividend was a $1.75 it's beta is 1.75 the market risk premium is 10.60% and the risk-free rate is 5.25% what is the current price of the common stock A company is presently enjoying relatively high growth because of a surge in the demand for its new product management expects earnings and dividends to grow at a rate of 34% for the next two years 20.85% in year three and four and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6.00% the company's last dividend was a $1.75 it's beta is 1.75 the market risk premium is 10.60% and the risk-free rate is 5.25% what is the current price of the common stock

Explanation / Answer

Current price of Stock is $ 19.54

Working:

Step-1:Calculation of cost of Equity As per Capital Asset Pricing Model, Required rate of return = Risk Free rate + Beta *market risk premium = 5.25% + 1.75 * 10.60% = 23.80% Step-2:Calculation of Present Value of four years dividend Year Dividend Discount factor @ 23.80% Present Value 1 $       2.35      0.8078 $       1.89 2 $       3.14      0.6525 $       2.05 3 $       3.80      0.5270 $       2.00 4 $       4.59      0.4257 $       1.95 Total $       7.90 Working: Year Last years dividend Growth rate Current Years dividend 1 $       1.75 34.00% $       2.35 2 $       2.35 34.00% $       3.14 3 $       3.14 20.85% $       3.80 4 $       3.80 20.85% $       4.59 Step-3:Calculation of terminal value of dividend Terminal Value of dividend = D4*(1+g)/(Ke-g) Where, = 4.59*(1+0.06)/(0.238-0.06) D4 $       4.59 = $    27.33 g 6.00% Ke 23.80% Step-4:Calculation of present value of terminal value Present Value of terminal value of dividend = $    27.33 x      0.4257 = $    11.64 Step-5:Calculation of present value of all dividends Present Value of all dividend = $       7.90 + $    11.64 = $    19.54 As per dividend discount model, price of stock is the present value of all dividends. Thus, Price of Common Stock is $ 19.54

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.