The Beta is 1.85 not 1.75 Expert Q&A; Done A company is presently enjoying a rel
ID: 1172224 • Letter: T
Question
The Beta is 1.85 not 1.75Expert Q&A; Done A company is presently enjoying a relatively high growth because of a surge in the demand for its new product management expects earnings and dividends to grow at a rate of 29% for the next two years 18.60% in three years and four and after which competition will probably reduce the growth rate in earnings and dividends to constant growth growth rate of 5.95% of the company's last Dividend was $1.00 it's beta is 1.75 the market risk premium is 10.60% and the risk-free rate is 5% what is the current Price of the common stock
Explanation / Answer
Step-1:Calculation of cost of Equity As per Capital Asset Pricing Model, Required rate of return = Risk Free rate + Beta *market risk premium = 5.00% + 1.85 * 10.60% = 24.61% Step-2:Calculation of Present Value of four years dividend Year Dividend Discount factor @ 24.61% Present Value 1 $ 1.29 0.8025 $ 1.04 2 $ 1.66 0.6440 $ 1.07 3 $ 1.97 0.5168 $ 1.02 4 $ 2.34 0.4148 $ 0.97 Total $ 4.10 Working: Year Last years dividend Growth rate Current Years dividend 1 $ 1.00 29.00% $ 1.29 2 $ 1.29 29.00% $ 1.66 3 $ 1.66 18.60% $ 1.97 4 $ 1.97 18.60% $ 2.34 Step-3:Calculation of terminal value of dividend Terminal Value of dividend = D4*(1+g)/(Ke-g) Where, = 2.34*(1+0.0595)/(0.2461-0.0595) D4 $ 2.34 = $ 13.29 g 5.95% Ke 24.61% Step-4:Calculation of present value of terminal value Present Value of terminal value of dividend = $ 13.29 x 0.4148 = $ 5.51 Step-5:Calculation of present value of all dividends Present Value of all dividend = $ 4.10 + $ 5.51 = $ 9.61 As per dividend discount model, price of stock is the present value of all dividends. Thus, Price of Common Stock is $ 9.61
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.