Question

The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D₁) at the end of the current year will be $1.20. The growth rate (g) is 10 percent and the discount rate (K_e) is 14 percent.

a. What should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)

b. If there is a 6 percent total underwriting spread on the stock, how much will the issuing corporation receive? (Do not round intermediate calculations and round your answer to 2 decimal places.)

c. If the issuing corporation requires a net price of $28.50 (proceeds to the corporation) and there is a 6 percent underwriting spread, what should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Answer 1

a) Price of share = D1/Ke-g

D1 = Dividend of next period

Ke = required rate of return

g = growth rate

Thus price of stock = 1.20/(14%-10%)

=1.2/4%

=30$

b) If there is 6% total underlwriting spread , then issuing corporation will get

Price of stock(1-underlwriting spread)

=30(1.6%)

=30(0.94)

=28.2$

c) If  issuing corporation requires a net price of $28.50 and there is a 6 percent underwriting spread, than price of stock = amount required/1-6%

= 28.50/0.94

= 30.32 $

Thus price of stock should be 30.32 $