Question

Scipio Auto is expecting its earnings and dividends to grow at a rate of 19% next 5 years. After the period, the firm is expecting to grow at the industry average of 5% forever. If the firm recently paid a dividend of $1.25, and the required rate of return is 12%, what is the most you should pay for this company's stock?

a. $21.28

b. $27.08

c. $32.91

d. $53.52

Answer 1

D1=(1.25*1.19)=$1.4875

D2=(1.4875*1.19)=$1.770125

D3=(1.770125*1.19)=$2.10644875

D4=(2.10644875*1.19)=$2.506674013

D5=(2.506674013*1.19)=$2.982942075

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)

=(2.982942075*1.05)/(0.12-0.05)=$44.74413112

Hence current price=Future dividends*Present value of discounting factor(12%,time period)

=$1.4875/1.12+$1.770125/1.12^2+$2.10644875/1.12^3+$2.506674013/1.12^4+$2.982942075/1.12^5+$44.74413112/1.12^5

which is equal to

=$32.91(Approx).