Question

Assume that the average firm in your company's industry is expected to grow at a constant rate of 5% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $3. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 20% during the second year (g1,2 = 20%). After Year 2, dividend growth will be constant at 5%. What is the estimated value per share of your firm’s stock? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Average Firm in Industry:

Dividend Yield = 8%
Growth Rate = 5%

Required Return = Dividend Yield + Growth Rate
Required Return = 8% + 5%
Required Return = 13%

Your Company:

D0 = $3.00
g0,1 = 50%
g1,2 = 20%
Constant growth rate, g = 5%
Required Return, r = 13%

D1 = $3.00 * 1.50 = $4.50
D2 = $4.50 * 1.20 = $5.40
D3 = $5.40 * 1.05 = $5.67

P2 = D3 / (r - g)
P2 = $5.67 / (0.13 - 0.05)
P2 = $70.875

P0 = $4.50/1.13 + $5.40/1.13^2 + $70.875/1.13^2
P2 = $63.72

So, estimated value per share is $63.72