Question

Suppose the Fargo Co.’s dividend grows at a 20 percent rate for the next three years....

Suppose the Fargo Co.’s dividend grows at a 20 percent rate for the next three years. Thereafter, its growth will be at a at a 2 percent rate. Its beta is 1.20, risk free rate is 3% and the market expected return is 10%. Find out the cost of equity using CAPM and then calculate the value of a share of Fargo Co. The company’s most recent dividend was $3

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Answer #1

CAPM return : Rf+ Beta*(Rm-Rf) = 3%+1.2*(10%-3%) = 11.4%

Refer table below for calulations :

Share price at end of year 3 will be = D4 / (Ke-g)

D4 = 3*120%*120%*120%*102% = 5.287 / (11.4%-2%) = $56.25

Now, discount this to year 0 = $56.25 / (1+11.4%)^3 = $40.68

Dicountind year 1 to year 3 dividend

Adding the value of $10.46 + $ 40.68 = $51.14 (Share price today)

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