Question

McGaha Enterprises expects earnings and dividends to grow at a rate of 22% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D₀, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

a. $26.57

b. $26.10

c. $25.16

d. $25.63

e. $24.69

Answer 1

required return = 3% + 1.20*5.5% = 9.60%

price = 26.57 (see table below)

Discount rate	9.6000%
Cash flows	Year	Discounted CF= cash flows/(1+rate)^year	Cumulative cash flow
-	0	-	-
1.525	1	1.39	1.39
1.861	2	1.55	2.940
2.270	3	1.72	4.664
2.769	4	1.92	6.583
28.846	4	19.99	26.57