Question

You expect Sharp Steel Company to pay a dividend of $2.37 per share next year. You expect the dividend to grow 10% the following year, 7% the year after that, and then level off to a growth rate of 4% indefinitely. Sharp has a beta of 1.4, the risk-free rate of return is 1.1% and the market risk premium is 5.7%.

a) What is Sharp Steel's stock worth?

b) If Sharp's stock was currently trading for $62.10, would you buy it?

Answer 1

(a) first we need to ke i.e, equalization rate.

Ke = 1.1% + 1.4(5.7%)

= 9.08%

Year	dividend	present value Factor	Discounted Cash flow
1	$2.37×1.1 = $2.61	1/1.0908 = 0.92	$2.40
2	$2.61×1.07 = $2.79	1/(1.0908)^2 = 0.84	$2.34
3	$2.79×1.04 = $2.90	1/(1.0908)^3 = 0.77	$2.23
Price at the end of year 3	$2.90/(9.08%-4%) = $57.08	1/(1.0908)^3) = 0.77	$43.95
		Total price	$50.93

Stock worth is $50.92

(b) If Sharp's stock was currently trading for $62.10, we should sell it as the stock is overpriced as per the market. Hence sell the stock