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 $