Question

Consider the stock of SLB Inc., a growth stock that will pay no dividend the next...

Consider the stock of SLB Inc., a growth stock that will pay no dividend the next year. Starting in year two, the company will pay a dividend of $3 and will increase it by 10% for the next three years. Afterwards, dividends will grow by 5% per year indefinitely. The stock has a required rate of return of 15%. Answer the following questions. (SHOW YOUR WORK. Correct answers with no formulas/calculations receive no credit)

a) What is the value (price) of the stock today (i.e. P0)? Show your work and formulas.

b) What is the price of the stock at t=10, assuming the required rate of return (i.e. 15%) and the growth rate of dividends (i.e., 5%) do not change? Show your work and formulas.

c) What is the price of the stock at t=1, assuming the required rate of return (i.e. 15%) and the growth rate of dividends (i.e., 5%) do not change? Show your work and formulas.

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Homework Answers

Answer #1

a). D1 = $0

D2 = $3

D3 = D2 * (1 + g1) = $3 * (1 + 0.10) = $3.30

D4 = D3 * (1 + g1) = $3.3 * (1 + 0.10) = $3.63

D5 = D4 * (1 + g1) = $3.63 * (1 + 0.10) = $3.993

D6 = D5 * (1 + gC) = $3.993 * (1 + 0.05) = $4.19

P5 = D6 / (r - gC) = $4.19 / (0.15 - 0.05) = $41.93

P0 = [D2/(1 + r)2] + [D3/(1 + r)3] + [D4/(1 + r)5] + [(D5+P5)/(1 + r)5]

= [$3/(1+0.15)2] + [$3.3/(1+0.15)3] + [$3.63/(1+0.15)4] + [($3.993+$41.93)/(1+0.15)5]

= $2.27 + $2.17 + $2.08 + $22.83 = $29.34

b). P10 = P5 * (1+gC)5 = $41.93 * (1 + 0.05)5 = $53.51

c). P0 = [P1+D1]/[1+kE]

$29.34 = [P1 + 0] / [1 + 0.15]

P1 = $29.34 * 1.15 = $33.75

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