Question

Assume that the average firm in your company’s industry is expected to grow at

a constant rate of 5% and that its dividend yield is 7%. Your company is about as

risky as the average firm in the industry, but it has just successfully completed some

R&D work that leads you to expect that its earnings and dividends will grow at a rate

of 50% this year and 20% the following year, after which growth should return to the 5% industry average. If the last dividend paid (D0) was $1, what is the value per share of your firm’s stock?

Answer 1

Answer :- Value per share = $ 24.30

Calculation of Stock Price :-

D0 = 1.00

D1 = 1.00 * 1.50 = 1.50

D2 = 1.50 * 1.20 = 1.80

D3 = 1.80 * 1.05 = 1.89

P3 = D3 / (required return - growth rate) = 1.89 / (12% - 5%) = 27

Price = D1 / (1+return) + D2 / (1+return)2 + P2 / (1+return)2

So Price = [1.50 / (1.12)] + [1.80 / (1.12)2)] + [27 / (1.12)2] = 24.30

Note :- Calculation of required rate of return :- = (Dividend / Share Price) + Growth

As dividend yield = Dividend / Share Price

and it is given as 7%

So replacing (Dividend / Share Price) with Dividend Yield in required rate of return formulae

Required rate of return = (Dividend / Share Price) + Growth

= 7% + 5%

  = 12%