Question

Golden Corp. is a young start-up company and therefore is not paying any dividends on the stock over the next 7 years. However, the following year, the company will start paying a dividend of $27 per share (at the end of the year following year 7) and thereafter it will increase the dividends by 6% per year forever. If the required rate of return on this stock is 13%, what is the current (today’s) share price?

Do not use the $ sign. Use commas to separate thousands. Use to decimals. Round to the nearest cent. For example if you obtain $1,432.728 then enter 1,432.72;  if you obtain $432 then enter 432.00

Answer 1

Step 1: Computation of market price at the end of year 8 using Gordon Growth Model

P8 = D9 / (Ke – g)

Where,

P8 - Market price at the end of year 8 =?

D9 - Expected dividend in year 9 = 27*1.06 = 28.62

Ke – Cost of equity = 13%

G – Growth rate in dividen = 6%

P8 = 28.62/(.13-.06)

= 28.62/.07

= $408.86

Step 2: Computing current share price by discounting the cashflow at required return

Present value = Future value / (1+ rate per period)^ no. of periods

= (27+408.86)/1.13^8

= 435.86/2.65844419291

= $163.95