Question

HigherEducation, Inc., a private educational company's share price is $110 per share; earnings and dividends are $7.00 a share, and the growth rate is zero. They have just announced a new growth strategy whereby the company's earnings would begin growing by 3% per year and remain stable at this new rate. This new growth strategy will require the company to reinvest 50% of their earnings starting at the end of this year (t = 1). What will happen to the price per share of this company?

Answer 1

DDM equation:

D1 / (R-G) = P0

Current earnings and dividend $7 which will grow at 3%.

New earnings and dividend = $7*(1.03) = $7.21

Only 50% will be paid as a dividend now or $7.21 x 50% = $3.605

Calculate the required return from previous year’s data:

$110 = $7/R

R = 7/100

R = 6.363636%

.

Projected growth rate G = 3%

Now, we can calculate the new price by fetching new information in DDM model:

Price of equity = Expected dividend / (Required rate - Growth rate)

Price of equity = $3.605/(6.363636% - 3%)

Price of equity = $107.18