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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%.

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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Answer #1

Year 1 dividend = 4.05 * 1.17 = 4.7385

Year 2 dividend = 4.7385 * 1.17 = 5.54405

Year 3 dividend = 5.54405 * 1.1 = 6.09845

Year 4 dividend = 6.09845 * 1.05 = 6.40337

Required rate = Risk free rate + beta (market risk premium)

Required rate = 2% + 1.2 (7.6%)

Required rate = 11.12%

1)

Time 3 present value = D4 / required rate - growth rate

Time 3 present value = 6.40337 / 0.1112 - 0.05

Time 3 present value = 6.40337 / 0.0612

Time 3 present value = $104.63

2)

Price =  4.7385 / (1 + 0.1112)1 + 5.54405 / (1 + 0.1112)2 + 6.09845 / (1 + 0.1112)3 + 104.63 / (1 + 0.1112)3

Price = $89.46

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