Question

Nonconstant Growth Stock Valuation Assume that the average firm in your company's industry is expected to...

Nonconstant Growth Stock Valuation Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $3. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and and 25% during the second year (g1,2 = 25%). What is the required rate of return on your company’s stock? What is the estimated value per share of your firm’s stock?

Homework Answers

Answer #1

What is the required rate of return on your company’s stock?

The required rate of return, Ke = Dividend yield + Long term growth rate = 8% + 4% = 12%

What is the estimated value per share of your firm’s stock?

D0 = $ 3

g0,1 = 50%; g1,2 = 25% and g= 4% thereafter

D1 = D0 x (1 + g0,1) = $ 3 x (1 + 50%) = $ 4.50

D2 = D1 x (1 + g1,2) = $ 4.50 x (1 + 25%) = $ 5.625

D3 = D2 x (1 + g) = $ 5.625 x (1 + 4%) = $ 5.85

Horizon value of future dividends at the end of year 2 = HVyear2 = D3 / (Ke - g) = 5.85 / (12% - 4%) = $ 73.125

Value per share = PV of all future dividends + PV of horizon value

=$ 66.80

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