etallica Bearings, Inc., is a young start-up company. No dividends will be paid
ID: 2740314 • Letter: E
Question
etallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next seven years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a $12.85 per share dividend in year 8 and will increase the dividend by 5.50 percent per year thereafter.
If the required return on this stock is 12.50 percent, what is the current share price? (Select rounded answers as directed, but do not use the rounded numbers in intermediate calculations.)
Explanation / Answer
1. The price of the stock after 7 years
Year
cashflow
PVF @12.5%
Discounted cashflow
8
Dividend = $12.85
0.8889
$11.422
9
Dividend = $12.85 * 1.055 = $13.557
0.7901
$10.71
9
Price P9 = D11 /( Ke - g)
= 13.557 * 1.055 /(12.5% - 5.5%)
= 14.303 / 0.07 = $204.323
0.7901
$161.435
P7
= $183.56
since in the for the 7th year 8th year will be immediate year so PVF is taken for one year.
2. Value of share today = $183.56 * 1 / (1.125)7
= $133.56 * 0.4385
= $ 80.484
since the value of share today is what we receive tomorrow discounted at required rate of return so we'll receive prive at the 8th year discounted to today.
Year
cashflow
PVF @12.5%
Discounted cashflow
8
Dividend = $12.85
0.8889
$11.422
9
Dividend = $12.85 * 1.055 = $13.557
0.7901
$10.71
9
Price P9 = D11 /( Ke - g)
= 13.557 * 1.055 /(12.5% - 5.5%)
= 14.303 / 0.07 = $204.323
0.7901
$161.435
P7
= $183.56
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