Question

Metallic Bearings is a young start-up company. The firm plans to pay the following dividends - $9 in Year 1, $4
in Year 2 and $1 in Year 3. There will be no dividends paid on the stock over the next 9 years because the firm
needs to plow back its earnings to fuel growth. The company will then pay a dividend of $17.50 per share in Year
13 and will increase the dividend by 5.5% per year thereafter.
Required: Compute the current share price if the required return on this stock is 16%

Answer 1

Given about Metallic bearings,

Expected future dividends are

D1 = $9

D2 = $4

D3 = $1

no dividend will be paid for next 9 years

Dividend in year 13, D13 = $17.50

thereafter dividend will increase at g = 5.5%

required return on stock r = 16%

So, Stock price at year 12 using constant dividend growth model is

P12 = D13/(r - g) = 17.50/(0.16-0.055) = $166.67

So, stock price today of the stock is sum of PV of future dividends and P12 discounted at r

=> P0 = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + P12/(1+r)^12

=> P0 = 9/1.16 + 4/1.16^2 + 1/1.16^3 + 166.67/1.16^12 = $39.45

So, current share price = $39.45