Please show all work. On January 1, 1991, you are considering buying stock in Ge

Question

Please show all work.

On January 1, 1991, you are considering buying stock in Genetic Biology Systems (GBS), which has just announced a new type of corn that will provide nitrogen to the soil and thus eliminate the need for additional fertilizer. GBS had an EPS of $1.20 in 1990. The firm's expected annual growth rate is 50% for 1991 and 1992, 25% for the following two years, and 10% thereafter. Its dividend payout ratio is expected to be zero in 1990 and 1991, to rise to 20% for the following two years, and then to stabilize at 50% thereafter. The risk-free rate is 15%, and GBS has a beta of 1.2. The market rate of return is 16%. What is the value of GBS stock?

Explanation / Answer

cost of equity = IRF + (RM- IRF)*beta

                       = 15% + (16- 15)*1.2 = 16.2%

Value of Share = expected dividend / Ke - g = 2.320/ 16.2 %- 10% = 37.41

Value of GBS stock = 37.41

Year growth rate EPS dividend amount 1990 1.2 0 1991 50% 1.8 0 1992 50% 2.7 0.54 1993 25% 3.375 0.675 1994 25% 4.21875 2.109375 1995 10% 4.640625 2.3203125

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