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Earnings Inc. just paid a dividend of $4.05 per share. It should grow at a rate...

Earnings Inc. just paid a dividend of $4.05 per share. It should grow at a rate of 17% for each of the next two years, then 10% the year after and settle down to a growth rate of 5% per year thereafter. Its beta is 1.2, the market risk premium is 7.6% and T-bills trade at 2%.

How much is the dividend at time 1 (D1)?

How much is the dividend at time 2 (D2)?

How much is the dividend at time 3 (D3)?

What rate of return do investors require on this Earnings Inc. stock? [Enter the value in decimal format. For example, if your answer is 12.34%, enter as 0.1234]

What is the time-3 present value of all cash flows from time 4 on into the future?

At what price should Earnings Inc. stock sell today?

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Homework Answers

Answer #1

Answer(1): Dividend = $4.05, g1 = 17%, g2 = 17%, g3 = 10%

Next dividend = Current dividend (1+Growth rate)

Dividend at time 1 (D1) : 4.05 (1+.17) = $4.7385

Dividend at time 2 (D2) : 4.7385 (1+.17) = $5.544

Dividend at time 3 (D3): 5.544 (1+.10) = $6.0984

(2): Calculating of Required rate of return: From CAPM:

Re = Rf + Beta (Rpm)

Where; Re = Required rate of return, Rpm = Market risk premium, Rf = Risk free return.

Given: Re = ?, Rm = 7.6%, Rf = 2%, Beta = 1.2

Putting all the above values in the formula, we get:

Re = .02 + 1.2 (.076)

Re = .1112

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