Question

Q1:

Parabola Corp just paid out a dividend of $3.85/share to its shareholders today and promises to increase its dividend by 20% next year and then reduce the dividend growth rate by 5 percentage points per year until it reaches the industry average of 5% dividend growth in perpetuity. If shareholders expect a 13% return, what is the price of the stock today?

Q2:

Hyperbola Corp currently has no growth opportunities and pays out all of its earnings as dividends to its shareholders, with an enviable EPS of $8.25. It has a one-time investment opportunity in a year from now that will require an investment of $1.60/share at that time, but will increase the earnings per share by $2.10 and $2.45 for the subsequent two years. Once this project is done (after three years), Hyperbola Corp will once again return to its current dividend payout policy. Assume the cost of equity is 12%.

A) If Hyperbola does not take on the investment, what is its current share price?

B) If Hyperbola does take on this investment, what will its share price be today?

C) If Hyperbola does take on the investment, what will its share price be in four years time?

Answer 1

Answer to Question 1:

Last Dividend, D0 = $3.85

Growth Rate in Year 1 = 20%
Growth Rate in Year 2 = 15%
Growth Rate in Year 3 = 10%
Growth Rate in Year 4 and Onward, g = 5%

D1 = $3.8500 * 1.20 = $4.6200
D2 = $4.6200 * 1.15 = $5.3130
D3 = $5.3130 * 1.10 = $5.8443
D4 = $5.8443 * 1.05 = $6.136515

Required Return, rs = 13%

P3 = D4 / (rs - g)
P3 = $6.136515 / (0.13 - 0.05)
P3 = $6.136515 / 0.08
P3 = $76.70644

P0 = $4.62/1.13 + $5.313/1.13^2 + $5.8443/1.13^3 + $76.70644/1.13^3
P0 = $65.46

Therefore, price of the stock today is $65.46