We will now consider the same information again. A firm’s total annual dividend

Question

We will now consider the same information again. A firm’s total annual dividend payout is $1 million. Its stock price is $45 per share and it has 17,500,000 shares outstanding. The firm earned $4 million in Net Income last year. This year, the firm expects earnings to grow at 7%, with growth the year after that expected to be 5%, and then in all following years, the firm expects earnings to grow at 3%. The firm plans to hold their dividend payout ratio constant over the coming 20 years and beyond. The risk free rate is 3%, beta for the dividend portion of the firm must be lower than for the entire income stream, and it measured at is 0.65, and the equity risk premium is 7.75%. What is the value of equity for the entire firm using the DIVIDEND DISCOUNT model, using annual dividends as free cash flow?

Explanation / Answer

Diivdend payout ratio=1/4=25%
Earnings this year=4*1.07=4.28 million
Earnings next year=4.28*1.05=4.494 million
Earnings after that=4.494*1.03=4.62882 million

cost of equity=risk free rate+beta*market risk premium=3%+0.65*7.75%=8.038%
Share Price=(4.28*25%/1.08038+4.494*25%/1.08038^2+4.62882*25%/((8.038%-3%)*1.08038^2))*10^6/17500000=1.2361

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