Question

Wally’s Warehouses just went public with an initial public offering of stock. Wally’s stock is not expected to pay any dividends for the next two years. One year after that time (i.e three years from now), Wally’s will pay a $1.00 per share dividend which will grow the next year to $2.00 per share. After this, the dividend will decline by 5% per year forever from that point in time as Wally’s warehouses become obsolete. Wally’s Warehouses is too new to have a Beta yet, but analysts think its Beta should be 0.8. Analysts also think that the S&P 500 can earn a steady state return of 10% annually and currently US treasury bonds yield 2% annually. Calculate the price that you should pay today for a share of Wally’s Warehouses stock

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Answer 1

Required rate = Risk free rate + Beta (Market rate-Risk free rate)
		2% + 0.8 (10%-2%) = 8.40%
Horizn value at Year-4 = Expected dividend of Year-5 / (Required rate+Decline rate)
		(2.00-5%) / (8.40+5%) =14.18
Year	Cashflows	PVF at 8.40%	Present value
1	0	0.922509	0
2	0	0.851023	0
3	1	0.785077	0.785077
4	2	0.724241	1.448481
4	14.18	0.724241	10.26973
Stock price			12.5
Todays stock price = 12.50