Question

The Blinkelman Corporation has just announced that it plans to introduce a new solar panel that will greatly reduce the cost of solar energy. As a result, analysts now expect the company’s earnings, currently (year 0) $1.00 per share to grow by 50 percent per year for the next three years, by 25 percent per year for the following 3 years, and by 9 percent per year thereafter. Blinkelman does not currently pay a dividend, but it expects to pay out 15 percent of its earnings beginning 2 years from now. The payout ratio is expected to become 35 percent in 5 years and to remain at that level. The company’s marginal tax rate is 40 percent. If you require a 17 percent rate of return on a stock such as this, how much would you be willing to pay for it today? Use Table II to answer the question. Round your answer to the nearest cent.

Answer #1

Statement shwoing Value of stock today

Year | Earnings | DPS | PVIF @ 17% | PV | ||

A | B | A x B | ||||

1 | 1 x 1.5 = | 1.50 | 0.8547 | 0.00 | ||

2 | 1.50 x 1.5 = | 2.25 | 2.25 x 15% = | 0.34 | 0.7305 | 0.25 |

3 | 2.25 x 1.5 = | 3.38 | 3.38 x 15% = | 0.51 | 0.6244 | 0.32 |

4 | 3.38 x 1.25 = | 4.22 | 4.22 x 15% = | 0.63 | 0.5337 | 0.34 |

5 | 4.22 x 1.25 = | 5.27 | 5.27 x 35% = | 1.85 | 0.4561 | 0.84 |

6 | 5.27 x 1.25 = | 6.59 | 6.59 x 35% = | 2.31 | 0.3898 | 0.90 |

Horizon Value | 89.81 | 89.81 x 35% = | 31.43 | 0.3898 | 12.25 | |

Price per share | 14.90 |

Thus Value of Stock today = $ 14.90

Note:

Horizon Value = EPS for year 7 / Required rate of retun - growth
rate

required rate of return = 17%

Growth rate = 9%

EPS for year 7 = EPS for year 6(1+ growth rate)

EPS for year 7 = 6.59(1+9%)

= 6.59(1.09)

= 7.185

Thus Horizon Value = 7.185/17%-9%

=7.185/8%

= 89.81 $

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