Pharmecology just paid an annual dividend of $1.55 per share. It\'s a mature com

Question

Pharmecology just paid an annual dividend of $1.55 per share. It's a mature company, but future EPS and dividends are expected to grow with inflation, which is forecasted at 3.75% per year. The nominal cost of capital is 10.50%. a. What is Pharmecology's current stock price? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Current stock price b. What would be Pharmecology's current stock price using forecasted real dividends and a real discount rate? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Current stock price

Explanation / Answer

Solution: Annual Dividend $1.55 per share Growth Rate/Inflation Rate 3.75% i.e 0.0375 Cost of Capital 10.50% i.e 0.105 Current Stock Price a) Next Year Dividend would increase by Growth Rate Next Year Dividend= Current Dividend + Growth Rate $1.55+1.55*3.75% 1.608125 Stock Price = Next Year Dividend/(Cost of Equity/Capital - Growth) (1.55*1.0375)/(10.5%-3.75%) Current Stock Price = $23.82 b) We will first calculate the Real Discount Rate as Follows: (1+Nominal Interest Rate)=(1+Real Discount Rate)*(1+Inflation Rate) (1+0.105)=(1+Real Discount Rate)*(1+0.0375) (1.105)=(1+Real Discount Rate)*(1.0375) Real Discount Rate= (1.105/1.0375)-1 0.06506 Real Discount Rate = 6.51 % Growth = 0 in Real Terms Price = Dividend +Dividend/Real Discount Rate $1.55+$1.55/0.06506 ($1.55*0.06506+$1.55)/0.06506 Current Stock Price = $25.37

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