Nonconstant Growth Stock Valuation Assume that the average firm in your company\

Question

Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 30% the following year, after which growth should return to the 4% industry average. If the last dividend paid (D0) was $2.75, what is the value per share of your firm's stock? Round your answer to the nearest cent. Do not round your intermediate computations.

Explanation / Answer

Calculation of value of the stock: Year 0 Year 1 Year 2 Year 3 Expected Dividend   $         4.1250 $                    5.3625 $              5.5770 (2.75 *150%) (4.125 *130%) (5.3625 *104%) Terminal value   $                 92.9500 = Dividend year 3 / (Required rate - Growth rate ) 5.5770 / (10%-4%) Required rate = Expected gowth + Dividend yield = 4% +6% = 10% Net cash flows $         4.1250 $                 98.3125 PVF (10%)    1.00000           0.90909                      0.82645 PV = Net cash flows * PVF $             3.75 $                      81.25 Value of the stock = Sum of PVs $    85.00

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