Question

Hammerville Corp. just paid a dividend of $1.25 p/s. On a recent investor call, the CFO
stated that the firm will be discontinuing its dividends for the next 3 years. In year 4 they are expecting to
pay a dividend of $.25 per share and that dividend will grow at 5% per year forever. Given the
following information, what is the per share price of Hammerville Corp.
Risk-free rate = 1%
Market Risk Premium = 4%
Covariance of Hammerville Corp. stock with the market = .11753
Standard deviation of the market = 28%

Answer 1

Variance of Market = (Standard Deviation of Market)^2
Variance of Market = 0.28^2
Variance of Market = 0.0784

Beta = Covariance of Stock with Market / Variance of Market
Beta = 0.11753 / 0.0784
Beta = 1.50

Required Return, rs = Risk-free Rate + Beta * Market Risk Premium
Required Return, rs = 1.00% + 1.50 * 4.00%
Required Return, rs = 7.00%

Dividend in Year 4, D4 = $0.25
Growth Rate, g = 5.00%

Stock Price in Year 3, P3 = D4 / (rs - g)
Stock Price in Year 3, P3 = $0.25 / (0.07 - 0.05)
Stock Price in Year 3, P3 = $12.50

Current Stock Price, P0 = P3 / (1 + rs)^3
Current Stock Price, P0 = $12.50 / 1.07^3
Current Stock Price, P0 = $10.20