Question

Widget Manufacturers Inc. just paid a $3 per share dividend. It is expected that dividends will grow at 10.00% per year for the next 2 years, at 6.00% the third year and 3.00% every year thereafter. Widget’s’ equity beta is 0.90, while the risk-free rate is 3.20% per year and the market risk premium is 6.00% per year. Based on this information, compute the price per share of Widget stock.

Round your answer to the nearest penny. For example, $2,371.243 should be entered as 2371.24

Answer 1

Ans : Expected rate of return = Rf + Beta ( market premium)

= 3.2 % + 0.9 ( 6 % )

= 3.2 % + 5.4 %

= 8.6 %

Price of Widget stock P0 = D 1 /(1+ Ke) + D2 /(1+Ke)² + D3 / (1+Ke)³ + D4 / ( Ke - g)

D1 = $ 3 * (1.1)

= 3.3

D2 = $ 3.3 *(1.1)

= $ 3.63

D3 = $ 3.63 * (1.06)

= $ 3.8478

D4 = $ 3.8478 * ( 1.03)

= $ 3.9632

P0 = D 1 /(1+ Ke) + D2 /(1+Ke)² + D3 / (1+Ke)³ + D4 / ( Ke - g)

= $ 3.3 / (1+ 0.086) + $ 3.63 / (1 + 0.086)² +  $ 3.8478 / ( 1 + 0.086 )³ + $ 3.9632 / ( 0.086 - 0.03 )

= $ 3.3 * 0.9208 + $ 3.63 * 0.84789 + $ 3.8478 * 0.7807 + $ 3.9632 / 0.056

= $ 3.038674 + $ 3.0778 + $ 3.00416 + $ 70.7714

= $ 79.8921

= $ 79.89

= $ 79.89