Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $10 per share annual dividend 10 years from today and will increase the dividend by 6 percent per year thereafter. If the required annual return on this stock is 11 percent, what is the current share price?

Answer 1

Answer = $78.18

We would use constant dividend growth formula.The general form of constant growth formula is:

P_t = [D_t(1+g)]/(r-g)

This means that since we will use the dividend in Year 10, we will be finding the stock price in Year 9.So, the price of the stock in year 9 is:

P₉ = D₁₀/(r-g)

= $10/(0.11-0.06)

= $200

The price of the stock today is simply the present value of the stock price in the future. We simply discount future price at required return. The price of the stock today will be:

P₀ = $200/1.11⁹

^{= $78.18}

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