1. A company will pay $2 dividends next year. These dividends are expected to gr
ID: 2664239 • Letter: 1
Question
1. A company will pay $2 dividends next year. These dividends are expected to grow at a rate of 15% for four years. Afterwards, the long term growth rate is expected to settle at 4%. The published beta for the stock is 1.2, the expected rate of return on the market is 13% and the current risk free rate is 3%.a. Calculate the company’s dividends to from year 1 to year 5?
b. MVI’s beta is 1.6, the expected return on the market is currently 12.75 percent, and the risk free rate is 4%? What should be the company’s required return?
c. Calculate the company’s stock price at the end of year 4 as the constant growth period begins.
d. Calculate the company’s stock price today.
Explanation / Answer
a. D1= $2 g =0.15
Year Dividend
1. D1(1+g)^n = $2(1+.15)^1 = $2.30
2. $2(1+.15)^2 = $2.64
3. $2(1+.15)^3 = $3.04
4. $2(1+.15)^4 = $3.50
5. $3.50(1+.04)^1 = $3.64
b. E(R) = Rf + [E(Rm)-Rf ] Beta
E(R) = 4% + [12.75% - 4% ] 1.6
E(R) = 18%
c. Company's stock price at end of 4th year = Divindend in 5th year /E(R)- g
= $3.64/.18-.04 = $ 26
d. Today company's stock price =
E(R)= Rf + [E(Rm)-Rf ] Beta
E(R) = 3% + [13% - 3% ] 1.2
E(R) = 15%
Pv of dividends(15%)= 2.30/(1+.15)^1 + 2.64 /(1+.15)^2 + 3.04/(1+.15)^3 + 3.50/(1+.15)^4
= 2 + 2 +2+2 =$ 6
PV of $26 today at 15% discount rate = $26/(1.15)^4 = $14.87
Today company's stock price = $14.87 + $6 = $20.87
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