Question

MG Inc. is a profitable company that is not paying a dividend on its common stock....

MG Inc. is a profitable company that is not paying a dividend on its common stock. Analyst Weber believes that MG will begin paying a $4.00 per share dividend in five years and that the dividend will increase 7% annually thereafter. If Weber believes the required return for MG is 12%, what is his estimated current value of MG’s common stock?

a. $50.84
b. $80.00
c. $33.33
d. $72.46
e. $45.39
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Homework Answers

Answer #1

No dividends will be paid on the stock over the next 4 years. Once the stock begins paying dividends, it will have a constant growth rate of dividends.

Pt = [Dt × (1 + g)] / (R − g)

The price of the stock in Year 4 will be:

P4 = D5 / (R − g) = $4.00 / (0.12 − 0.07) = $80

The price of the stock today is simply the PV of the stock price in the future. We simply discount the future stock price at the required return. The price of the stock today will be:

P0 = $80 / 1.12^5 = $45.39

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