X-Tech is a new Internet venture. It\'s first year dividend is expected to be $3
ID: 2719827 • Letter: X
Question
X-Tech is a new Internet venture. It's first year dividend is expected to be $30. The risk-adjusted discount rate for this company is 10%. However, the growth prospect of X-Tech is uncertain. Some analysts believe it will grow 4% per year. Another group believe it can grow as fast as 5.5% per year. Calculate the equity value of X-Tech under each of those assumptions. Plot a graph showing the stock value of the company for a range of future growth rates between 3% to 6% (step size of 0.1%) Assume that the growth rate is fixed at 5.5%. However, analysts disagree with each other on the right discount rate to apply for the company. Some believe 8% is correct, but the other group thinks 6% is a more precise value. Plot the stock price of the company as a function of discount rate for the range of 6% to 12% (step size of 0.1%) Now assume that everybody agrees that the growth rate is 5% and discount rate is 7%. However, they believe that the due diligence process of the firm has not been done carefully. There is a range of estimation for the dividend of the first year, which varies between $20 to $100. Plot the stock price as a function of first-year dividends (step size of $5). What difference do you observe compared to the results of parts (1) and (2)? Can you relate what you learn from this question to an important historical event? Explain it.Explanation / Answer
1) Equity Value of X - TECH
If growth rate is 4% P0 = D1/(Ke - g) = 30/(0.10-0.04) = $ 500
5.5% = 30/(0.10-0.055) = $ 666.68
Values to plot the graph :
The plotted graph will be as under:
2) Stock price as a function of discount rates:
The data are given below:
The graph is pasted below:
3) Dividend and stock prices are as below:
Seeing the charts, the following can be observed:
Chart 1 - as the growth rate increases, (other things remaining constant) the stock value increases, which increase is non-linear
Chart 2 - as the discount rate increases (other things remaining constant) he stock value decreases, which increase is non-linear
Chart 3 - as the first year dividend increases (other things remaining constant) the stock price increases.which increase is linear
Growth Stock Rate (%) Value ($) 3.0 428.57 3.1 434.78 3.2 441.18 3.3 447.76 3.4 454.55 3.5 461.54 3.6 468.75 3.7 476.19 3.8 483.87 3.9 491.80 4.0 500.00 4.1 508.47 4.2 517.24 4.3 526.32 4.4 535.71 4.5 545.45 4.6 555.56 4.7 566.04 4.8 576.92 4.9 588.24 5.0 600.00 5.1 612.24 5.2 625.00 5.3 638.30 5.4 652.17 5.5 666.67 5.6 681.82 5.7 697.67 5.8 714.29 5.9 731.71 6.0 750.00Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.