Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 13 years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $13 per share 14 years from today and will increase the dividend by 5 percent per year thereafter.

If the required return on this stock is 12 percent, what is the current share price?

Answer 1

Calculation of Current share price:

Year	Cash flow (1)	Discount rate @12% (2)	Discounted Cash flows (3) (1*2)
1	13	1/1.12= 0.893	11.609
2	13	1/(1.12)^2=0.797	10.361
3	13	1/(1.12)^3=0.712	9.256
4	13	1/(1.12)^4=0.635	8.255
5	13	1/(1.12)^5=0.567	7.371
6	13	1/(1.12)^6=0.506	6.578
7	13	1/(1.12)^7=0.452	5.876
8	13	1/(1.12)^8=0.404	5.252
9	13	1/(1.12)^9=0.361	4.693
10	13	1/(1.12)^10=0.322	4.186
11	13	1/(1.12)^11=0.287	3.731
12	13	1/(1.12)^12=0.256	3.328
13	13	1/(1.12)^13=0.229	2.977
14	13	1/(1.12)^14=0.205	2.665
14	195 (Note)	1/(1.12)^14=0.205	39.975
		Current share price	126.113

Current share price = 126.113

Note:

Calculation of price 14th year:

P14 = D15/Ke-g

D15 = D14+growth

D14 = 13

Growth rate (g) = 5%

Required rate of return (ke) = 12%

D15 = 13+13*5%

= 13+0.65

= 13.65

D15 = 13.65

P14 = 13.65/12%-5%

= 13.65/7%

= 195