Question

Shelby Enterprises is expecting a growth rate of 14% for the next two years due to a new series of cars that they are coming out with. After the next two years, they are anticipating a steady 8% growth rate which should continue in perpetuity. The last dividend paid was $0.65 per share. Investors of Shelby Enterprises recognize the risk of the company and require a 12% rate of return. With all these variables, please tell me what the company should be priced at (per share).

Answer 1

Calculation of price per share:

Price per share as per dividend discount model

P0 = D0(1+g)/(Ke-g)

Where P0 = Price per share

D0(1+g). = Current year dividend

Ke.= rate of return

g. = growth rate

Here we have to calculate the present value of 1 and 2 yrs dividends and present value of terminal value.

So here last dividend paid(D0) = $0.65

Given for the first two years dividend will grow at a rate of 14% after that it grows at a rate of 8%.

So first year dividend =$0.65*(1+14%) = $0.741

Second year dividend = $0.741*(1+14%)=$0.845

Third year dividend = $0.845*(1+8%) = $0.913

Given Ke = 12%

Terminal value = $0.913/(12%-8%) =$22.83

Calculation of present value of dividend and terminal value

D1 =$0.741 * 0.893 =$0.662

D2 =$0.845 * 0.797=$0.673

Terminal value =$22.83 * 0.797 = $18.20

Price of the share =$0.662+ $0.673 +$18.20=$19.54.