Church Inc. is presently enjoying relatively high growth because of a surge in t

Question

Church Inc. is presently enjoying 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 25% for the next 3 years, after which competition will probably reduce the growth rate in earnings and dividends to 6%, i.e., g = 0.06. The companys last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00% (Hint: You will need this data to find the required return, rs, for Church, Inc.). What are the expected dividends during the high-growth period (D1, D2, D3,). Also, what is the current price of the common stock today (P0)? D1 = _______________. D2 = _______________. D3 = _______________. Stock Price Today (P0) = ____________________.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

D1 = D0*(1+g)^1 = 1.25*(1+25%)^1 = 1.5625 or 1.563

D2 = D0*(1+g)^2 = 1.25*(1+25%)^2 = 1.953

D3 = D0*(1+g)^3 = 1.25*(1+25%)^3 = 2.441

---------------

Part B:

You will have to calculate the present value of all future dividend and stock price at Year 4 to arrive at the current stock price.

Required Rate of Return = Risk Free Rate + Beta*(Market Risk Premium) = 3 + 1.20*5.5 = 9.60%

NPV = 1.563/(1+.096)^1 + 1.953/(1+.096)^2 + 2.441/(1+.096)^3 + 1.25*(1+.25)^3*(1+.06)^1/(.096 - .06)*(1+.096)^3 = $59.508 or $59.51

Answer is $59.508 or $59.51.

Thanks.

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