Question

Wicked Textiles Inc. just paid its annual dividend of $2.50 per share. The dividends are expected to grow for the next 2 years at 10% rate, and then slow down to a 4% annual rate forever. If investors require 15% return:

8) What is the terminal value of Wicked Textiles in Year 2 (P2)?

9) What should be the current stock price of Wicked Textiles?

10.) What is the current price of a $1,000 par value Treasury bond maturing in 10 years with an annual coupon rate of 8% and YTM of 9%?

Answer 1

Answer 8.

Last Dividend, D0 = $2.50

Growth rate for next 2 years is 10% and a constant growth rate (g) of 4% thereafter

D1 = $2.50 * 1.10 = $2.75
D2 = $2.75 * 1.10 = $3.025
D3 = $3.025 * 1.04 = $3.146

Required Return, rs = 15%

Terminal Value, P2 = D3 / (rs - g)
Terminal Value, P2 = $3.146 / (0.15 - 0.04)
Terminal Value, P2 = $3.146 / 0.11
Terminal Value, P2 = $28.60

Answer 9.

Current Price, P0 = $2.75/1.15 + $3.025/1.15^2 + $28.60/1.15^2
Current Price, P0 = $26.30

Answer 10.

Par Value = $1,000

Annual Coupon Rate = 8.00%
Annual Coupon = 8.00% * $1,000
Annual Coupon = $80

Time to Maturity = 10 years
Annual YTM = 9.00%

Current Price = $80 * PVIFA(9.00%, 10) + $1,000 * PVIF(9.00%, 10)
Current Price = $80 * (1 - (1/1.09)^10) / 0.09 + $1,000 * (1/1.09)^10
Current Price = $80 * 6.417658 + $1,000 * 0.422411
Current Price = $935.82