Use the following data to answer Q26 and Q27: Beachballs, Inc., expects abnormal

Question

Use the following data to answer Q26 and Q27: Beachballs, Inc., expects abnormally high earnings for the next 3 years due to the forecast of unusually hot summer. After the 3 year period, their growth will level off to its normal rate of 6%. Dividendns and earnings are expected to grow at 20% for years 1 and 2, and 15% in year 3. The last dividend paid was $ 1.00. 26.

If Sarah Paulsen requires a 10% return on Beachballs, Inc., the price she is willingly to pay for the stock is closest to:

If Sarah is planning on selling Beachballs, Inc., after one year, the price will be closest to:

Explanation / Answer

1)D1 = 1 (1+.20) = 1.2

D2 = 1.2(1+.20) = 1.44

D3 = 1.44 (1+.15) = 1.656

Terminal value at year3 = 1.656 (1+.06) /(.10-.06) = 1.656 *1.06 / .04 =$ 43.884

1)Price willing to pay = (PVF@10%,1*D1)......(PCF@10%,3 *TV)

     = (.90909* 1.2 )+(.82645* 1.44)+(.75131*1.656)+(.75131 * 43.884)

     = 1.0909+ 1.1901+ 1.2442+ 32.9705

     = $ 36.50 per share

2)Price after 1 year = (PVF@10%,1*D2)+(PVF@10%,2*D3)+(PVF@10%,3*TV(

            = (.90909*1.44)+(.82645* 1.656 )+(.82645* 43.884)

              = 1.3091+ 1.3686+ 36.2679

              = $ 38.95 per share

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