Question

Everest Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 29% for the next 2 years, 21.15% in year 3 and 4 and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 5.25%. The company’s last dividend was $1.15, its beta is 1.05, the market risk premium is 8.50%, and the risk-free rate is 6.50%. What is the current price of the common stock?

Answer 1

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

=6.5+(1.05*8.5)=15.425%

D1=(1.15*1.29)=$1.4835

D2=(1.4835*1.29)=$1.913715

D3=(1.913715*1.2115)=$2.318465723

D4=(2.318465723*1.2115)=$2.808821223

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

=(2.808821223*1.0525)/(0.15425-0.0525)=$29.05439152

Hence current price=Future dividends*Present value of discounting factor(15.425%,time period)

=$1.4835/1.15425+$1.913715/1.15425^2+$2.318465723/1.15425^3+$2.808821223/1.15425^4+$29.05439152/1.15425^4

which is equal to

=$22.18(Approx).