Question

1. LewCo announces on the evening of January 2, 2020 (after the split), that the recent housing crash and subsequent regulatory changes have reduced demand for their construction projects, resulting in a change to their earnings outlook and dividend policy. They announce that they plan to hold their dividend constant at $5 per year for the foreseeable future.
   1. What do you predict will be the new share price assuming the cost of capital is 27.2%?
   2. You believe the housing market will recover and LewCo will resume growing its dividend. What is the value of the company assuming dividends growth is zero for three years and then grows again at 6% per year? Hint: you might want to separate the value of the company into two pieces: the value for year 4 and beyond plus the value of the first 3 years.

Answer 1

a Value = dividend/cost of capital = 5/0.272=18.38

b

	Required rate=	27.20%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	0	0.00%	5		5	1.272	3.9308
2	5	0.00%	5		5	1.617984	3.09027
3	5	0.00%	5	25	30	2.058075648	14.57672
	Long term growth rate (given)=	6.00%			Value of Stock =	Sum of discounted value =	21.6

Where
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 3 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor