Stephen and Chris are also looking at issuing preferred and common stock to furt

Question

Stephen and Chris are also looking at issuing preferred and common stock to further expand TechU's businesses.   They also want to examine their existing stock value to get a picture of how much they can sell additional stock for. Help Stephen and Chris by answering the following questions.

1.) What if analysts expect TechU's dividend to grow by 25 percent for the next 3 years, but increased competition is expected to force their growth rate to a constant 6 percent thereafter. TechU just paid a dividend of $0.80, and investors’ rate of return is 14%. What is the value of TechU's stock today?

2.) TeleU, the company TechU is looking at purchasing, expected their dividend to grow at a rate of 35 percent for the next four years, then to drop to a growth rate of 15 percent for 2 more years, and then settle down to a 10 percent growth rate thereafter. TeleU just paid a dividend of $2.50. Investors’ required rate of return is 12 percent. What would TechU be willing to pay for TeleU's stock?

3.)Instead of common stock, TechU is also looking at issuing preferred stock so Stephen Jobs can retain close ownership in the company. The preferred stock has a par value of $50 and will pay a 5% dividend per year. If the required return for investors is 8%, what is the value of the preferred stock?

Explanation / Answer

(1)

Value of stock = Sum of present value of all future dividends

= $0.80 x [(1.25 / 1.14) + (1.25 / 1.14)2 + (1.25 / 1.14)3] + [$0.80 x (1.25)3 x (1.06) / (0.14 - 0.06)] / (1.14)3

= $0.80 x [1.0965 + 1.2023 + 1.3183] + $13.97

= $16.86

(2)

Value of stock = sum of PV of dividends during first 6 years + PV of perpetual dividend thereafter

Sum of PV of dividends = $27.28 [Calculations in following table]

PV of perpetual dividend starting year 7 = [$2.5 x (1.35)4 x (1.15)2 x 1.10 / (0.12 - 0.010)] / (1.12)6

= $306

NOTE: Out of 3 questions the 1st 2 have been answered.

Year Dividend Discount factor @12% Discounted dividend 1 3.38 0.89 3.01 2 4.56 0.80 3.63 3 6.15 0.71 4.38 4 8.30 0.64 5.28 5 9.55 0.57 5.42 6 10.98 0.51 5.56 PV of dividends = 27.28

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