Question

Changes in Growth and Stock Valuation Consider a firm that had been priced using a 9 percent growth rate and a 12 percent required rate. The firm recently paid a $1.90 dividend. The firm has just announced that because of a new joint venture, it will likely grow at an 11 percent rate. How much should the stock price change (in dollars and percentage)?

• $141.87, 67%

• $141.87, 206%

• $124.77, 59%

• $124.77, 169%

Answer 1

Step 1: Calculate the Stock Price at considered growth of 9% and cost of capital of 12%

Formula: P0 = Current Dividend*(1 + Growth Rate) / (Required Return - Growth Rate)

Price of the stock = 1.9(1.09)/(0.12-0.09) = $69.03

Step 2: Calculate the Stock Price at Revised growth of 11% and cost of capital of 12%

Formula: P0 = Current Dividend*(1 + Growth Rate) / (Required Return - Growth Rate)

Price of the stock = 1.9(1.11)/(0.12-0.11) = $210.90

Step 3: Calculate the change in Stock Price based on change in estimated growth

Change in Stock Price ($) = Value of stock at 11% Growth - Value of Stock at 9% Growth = 210.9-69.03 = $141.87

Change in Stock Price (%) = Change in Stock Price ($)/Original Stock Price at Growth of 9% = 141.87/69.03 = 206%

Correct Answer: Option 2 - $141.87 , 206%