P Industries just paid a dividend of $2.00 per share. P expects the coming year
ID: 2675213 • Letter: P
Question
P Industries just paid a dividend of $2.00 per share. P expects the coming year to be very good, and its dividend is expected to grow by 15% over the year. After the next year, though, P's dividend is expected to grow at a constant rate of 6.1% per year. The risk-free rate(rRF) is 6% and the market risk premium (RPm) is 4%.1) If P's beta is 1.1, what is the current intrinsic value of the firm's stock? Assume the market is in equilibrium.
2) P has 500,000 share outstanding and an investor holds 40,000 shares. Suppose P is considering issuing 100,000 new shares at a price of $50 per share. If the new shares are sold to outside investors, how much will the investor's investment in P be diluted on a per-share basis?
3) If the investor fully exercised that provision and avoided dilution, she would hold ? stocks worth ? after the new stock issue?
Explanation / Answer
The required rate of return = Risk free rate + Beta * Market risk premium = 6% + 1.1 * 4% = 10.4% The value of the firm at the end of 1st year using dividend discount model = 2 * (1 + 0.15) * (1 + 0.061) / ( 0.104 - 0.061 ) = $56.75 The intrinsic value of the firm's stock = 2 * (1+0.15) / (1 + 0.104) + 56.75 / (1+0.104)^2 = $48.65 Current share = 40,000 / 500,000 = 8% New share = 40,000 / (500,000 + 100,000) = 6.67% Dilution = 8% - 6.67% = 1.33% If the investor maintains his original share, number of stocks held = 8% * (500,000 + 100,000) = 48,000 Value of the shares = 48,000 * 50 = $2,400,000
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