ABC, Inc., is a young start-up company. No dividends will be paid on the stock o

Question

ABC, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a $12 per share dividend in year 10 and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13 percent, what is the share price three years from today? 1) $63.76 2) $72.05 3) $56.42 4) $150.00 Previous Page Next Page Page 9 of 20 Go to Subit 2 3 5 6 7 8 9 0 S D F G H J KL

Explanation / Answer

Dividend at year 10 = 12 /share
Dividend growth that year 11 = 12*(1+5%) = 12.6
Terminal Value of Dividends = 12.6/(Required rate - Growth) = 12.6/(13% - 5%) = 12.6/8% = 157.5
Total value At year 10 = 12 + 157.5 = 169.50

Value at year 3 = 169.50/(1+13%)7 = 72.0477 or 72.05

Option 2 is correct option.

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