Question

Big Red Machines, a startup, has come up with a new product and has seen significant customer demand. Due to reinvestment in the firm (100% plowback ratio) Big Red Machines will pay no dividends in the first 2 years. Beginning in the 3rd through 6th years, the firm expects to pay $1.50, $1.60, and $1.75 In the 6th year, the firm should see stable growth rates and thus begin a divided which grows at 3% per year. You plan to graduate 1 year from now, and hope to invest in Big Red Machines at that time. The expected rate of return is 8% What is the value of Big Red Machine's stock one year from today? ; Do not round your intermediate calculations. Round your final answer to two decimal places.

Answer #1

**The value of the stock is computed as shown
below:**

**= Dividend in year 3 / (1 + required rate of
return)**^{2}**+**
**Dividend in year 4 / (1 + required rate of
return)**^{3}**+ Dividend in
year 5 / (1 + required rate of
return)**^{4}**+ 1 / (1 +
required rate of return)**^{4}**[ ( Dividend in year 5 (1 + growth rate) / ( required rate
of return - growth rate) ]**

= $ 1.50 / 1.08^{2} + $ 1.60 / 1.08^{3} + $ 1.75
/ 1.08^{4} + 1 / 1.08^{4} x [ ($ 1.75 x 1.03) /
(0.08 - 0.03) ]

= $ 1.50 / 1.08^{2} + $ 1.60 / 1.08^{3} + $ 1.75
/ 1.08^{4} + $ 36.05 / 1.08^{4}

= $ 1.50 / 1.08^{2} + $ 1.60 / 1.08^{3} + $
37.80 / 1.08^{4}

**= $ 30.34**

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