Question

McGaha Enterprises expects earnings and dividends to grow at a rate of 45% 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?

a. $51.66

b. $51.06

c. $52.26

d. $50.46

e. $52.86

Answer 1

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

=3+(1.2*5.5)

=9.6%

D1=(1.25*1.45)=$1.8125

D2=(1.8125*1.45)=$2.628125

D3=(2.628125*1.45)=$3.81078125

D4=(3.81078125*1.45)=$5.525632813

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

=5.525632813/0.096

=$57.55867513

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

=$1.8125/1.096+$2.628125/1.096^2+$3.81078125/1.096^3+$5.525632813/1.096^4+$57.55867513/1.096^4

which is equal to

=$50.46(Approx).