The Cremmins Coat Company has recently completed a period of extraordinary growt

Question

The Cremmins Coat Company has recently completed a period of extraordinary growth, due to the popularity of its yellow jackets. Earnings per share have grown at an average compound annual rate of 15 percent, while dividends have grown at a 20 percent annual rate over the past 10 years. The current dividend (D0) rate is $2 per share. Current earnings are $3.25 per share. Earnings are expected to grow at an annual rate of 15 percent for the next three years and 6 percent per annum thereafter. Dividends are expected to grow by 25 percent during the coming year, by 15 percent per annum for the following two years, and by 6 percent per annum thereafter.

a. What price do you expect the stock to sell for today, if your required rate of return on equity for a firm of this risk level is 16 percent?

b. What price do you expect the stock to sell for at the beginning of year 2?

Explanation / Answer

Stock price is the PRESENT VALUE of future cash flows in the form of dividends Dividend Dividends PV F @ 16% Year 0 2 Year 1 2(1+0.25)= 2.5 2.5 0.86207 2.155175 Year 2 2.5(1+0.15)= 2.875 2.875 0.74316 2.136585 Year 3 2.875(1+0.15) = 3.30625 3.3063 0.64066 2.11821416 Year 3 3.30625*1.06=3.504625 Value of stable growth @ year 3 -d4/(r-g) 3.5046/(0.16-0.06) 35.046 35.046 0.64066 22.4525704 Total PRESENT VALUE 28.8625445 a) So, stock price today is 28.8625 or 28.86 Stock price @ beginning of Year 2 is the future value of 28.8625@16% ie. 28.8625*1.16 = 33.4805 ie. 33.48

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