Question

Omicron Company has just paid a dividend of $2 per share. Analysts of the company’s shares estimate a supernormal growth rate of 30% for the company for the next two years. Afterwards, the company is expected grow at a rate of 15% for another three years, before settling down to a stable growth rate of 7.5% forever. What is Omicron’s share price in two years’ time (after the second year of supernormal growth), assuming a required return of 12%?

Select one:

a. $94.63

b. $98.10

c. $101.96

d. $114.23

e. $128.88

Answer 1

Share price in two years time ( after the second year of supernormal growth)

Present value of super normal period from 1 to 2 years

PV2 = Σ Do (1+ Ga)1/ (1+r)1 + Do (1+ Ga)2 / (1+r)2

where PV2 = present value after 2 yerars

Do = dividend, Ga = super mnormal growth rate = 30% , r = investors required rate of return

by putting values in formula

PV2 = $ 5.01

PV4 = D2 (1+g)/(r -g) *1/(1+r)4

PV4 = present value of share after 2 yers of super normal growth

D2= dividend after 2 years

g = normal growth rate after super normal period = 15%

by putting values in formula

PV4 = 5.01( 1+ 0.15)/ ( 0.12 - 0.15) * 1/ ( 1+ 0.12)^2

= $153.101(-)