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

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