Question

McGaha Enterprises expects earnings and dividends to grow at a rate of 33% 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?

Answer 1

Required return=Risk free rate+Beta*Market risk premium

=3+(1.2*5.5)=9.6%

D1=(1.25*1.33)=$1.6625

D2=(1.6625*1.33)=$2.211125

D3=(2.211125*1.33)=$2.94079625

D4=(2.94079625*1.33)=$3.911259013

Value after year 4=(D4*Growth rate)/(Required return-Growth rate)

3.911259013/0.096

=$40.74228138

Hence current price=Future dividends*Present value of discounting factor(9.6%,time period)

=$1.6625/1.096+$2.211125/1.096^2+$2.94079625/1.096^3+$3.911259013/1.096^4+40.74228138/1.096^4

which is equal to

=$36.54(Approx).