Steel Safety Corporation is in the introductory stage of the industry lifecycle,

Question

Steel Safety Corporation is in the introductory stage of the industry lifecycle, so its sales and earnings have grown rapidly in recent years. To date, the company has chosen to retain all of its earnings rather than pay dividends. Analysts have projected that Steel Safety will continue to retain all of its earnings for another 10 years. Eleven years from today, the company is expected to pay its first dividend, which is predicted to be $25 per share. Analysis have also determined that the appropriate required rate of return on Steel Safety's stock is 16 percent. Compute the value of the stock today assuming that once the dividend payments start, the dollar amount will remain constant at $25 per share per war. (Hint: The first dividend is not paid until 11 years from today.) Assuming the dividend will grow at a constant rate of 5 percent per year once the payments begin, what is the- value of the stock today?

Explanation / Answer

According to the given information, the Company is paying the dividend in 11th year. The Company will pay a dividend of $25 per share from 11th year onwards. Required rate of return = 16% a) Using the dividend growth model, we can say that price of the stock in 10yrs would be                                               P10 = D11 / R                                                      = $25 / 0.16                                                      = $156.25 Discounting the Price of the stock to find the value of the price for today                                               P0 = P10 / (1 + R)^10                                                    = $156.25 / (1 + 0.16)^10                                                    = $156.25 / (1.16)^10                                                    = $156.25 / 4.41                                                    = $35.43 Therefore, the today's price of the stock is $35.43 b) Here the growth rate is given, therefore, we have to calculate the price of the stock in year-10 using the growth rate.                                                  P10 = D11 / (R-g)                                                         = $25 / (0.16 - 0.05)                                                         = $25 / 0.11                                                         = $227.27 If the stock will be worth $227.27 in 10yrs, then we can get the current value by discounting this price back by 10yrs at 16%                                                   P0 = P10 / (1+R)^10                                                        = $227.27 / (1+0.16)^10                                                        = $227.27 / (1.16)^10                                                        = $227.27 / 4.41                                                        = $51.53 The stock is therefore $51.53 worth today.

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