Question

Blossom Inc. has a patent that will expire in two years. The firm is expected to grow at 9.9 percent for the next two years and dividends will be paid at year end. It just paid a dividend of $1. After two years, the growth rate will decline to 3.9 percent immediately, and the firm will grow at this rate forever. If the required rate of return is 10 percent, value the firm’s current share price.

PLEASE SHOW STEPS!

Answer 1

Given, Company paid a dividend of $1, D0=$1

For the next two years, it grows at 9.9%

D1=D0*(1+9.9%)=$1*(1.099)=$1.099

D2=D1*(1+9.9%)=$1.099*(1+9.9%)=$1.2078

After that firm grows at 3.9% forever

D3=D2*(1+3.9%)=$1.2078*(1+3.9%)=$1.2549

Terminal value at year2=D3/(required rate-growth rate)=$1.2549/(10%-3.9%)=$20.57

Value of the Share price=(D1/(1+10%))+((D2+Terminal value at Year2)/(1+10%)^2))

=(1.099/1.1)+(21.78/1.1^2)

=1+18

=19

Value of the Share price=$19.0