XYZ Pharmaceutical, Inc. just got FDA approval for their new drug, Viagrina. The

Question

XYZ Pharmaceutical, Inc. just got FDA approval for their new drug, Viagrina. The company has never paid a dividend, but they expect to pay one for the first time by the end of the year. The expected dividend is $3.00 per share and the company expects that dividend to increase at a rate of 20% for five years. After that, XYZ expects to see its dividend growth limited by the growth rate the US economy, which on average is 4.5% per year. If the required rate of return for other startup pharmaceutical companies like XYZ is 11%, what should be the fair price of XYZ’s stock today?

Explanation / Answer

(A) Present Value of 5 Years Cash Flow Year Calculation Div Amt DF @ 11% Discounted Div amt D0 $         3.00 D1 = 3 + 20% $         3.60 0.9009 $       3.24 D2 = 3.6 + 20% $         4.32 0.8116 $       3.51 D3 = 4.32 + 20% $         5.18 0.7312 $       3.79 D4 = 5.184 + 20% $         6.22 0.6587 $       4.10 D5 = 6.22 + 20% $         7.46 0.5935 $       4.43 Total (A) $    19.07 (B) Terminal Value i.e. Value still Perpituity Po = D / (Ke - g) D6 = 7.46 + 4.5% 7.505 TV = 7.505 / (0.11 - 0.045) $            115.46 Present Value of terminal Value = $115.46.23 X .5935 $    68.53 Stock Price = (A) + (B) = 19.07 + 68.53 $               87.60

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