Question

The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D₁) at the end of the current year will be $1.80. The growth rate (g) is 8 percent and the discount rate (K_e) is 12 percent.

  
a. What should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b. If there is a 6 percent total underwriting spread on the stock, how much will the issuing corporation receive? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

c. If the issuing corporation requires a net price of $43.50 (proceeds to the corporation) and there is a 6 percent underwriting spread, what should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Answer 1

Requirement (a) :
DIVIDEND END OF CURRENT YEAR (D1) =$1.80
GROWTH (G) = 8%
DISCOUNT RATE (Ke) =12%
STOCK PRICE = D1 /(Ke - G)
= $1.80 / (12% - 8%)
= $45
Requirement (b) :
UNDERWRITTING SPREAD = 6%
NET AMOUNT RECEIVED BY CORPORATION = $45- (6% * $45)
= $45-$2.7
= $42.3
Requirement ©:
CORPORATION REQUIRES NET PRICE = $43.5
UNDERWRITTING SPREAD = 6%
STOCK PRICE TO THE PUBLIC = ($43.5 / 94%) * 100%
= $46.28
EXPLANATION:-
LET THE ISSUE PRICE BE =$100
UNDERWRITTING SPREAD = 6%
NET PRICE RECEIVED BY CORPORATION = $94
WHEN CORPORATION RECEIVES $94 ISSUE PRICE IS =$100
WHEN CORPORATION RECEIVES $43.5 ISSUE PRICE = $100 / $94 * $43.5
					$   46.28