MJSProblem 7-12 Nonconstant Growth Stock Valuation Assume that the average firm

Question

MJSProblem 7-12
Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 5%. Your company is about as risky as the average firm in the industry and just paid a dividend (D0) of $1. You expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 20% during the second year (g1,2 = 20%). What is the required rate of return on your company’s stock? What is the estimated value per share of your firm’s stock?

$   

Explanation / Answer

Solution:

The required rate of return would be :

Current price can be calculted from dividend yield:

5% = dividend /Current market price

.05 = 1/x

Current market price = 1/.05

= $20

Ke = D1 /Po + G

Dividedn D0 = 1

Hence 1st year = 1* 1.5 = 1.5

2nd year = 1.8 in second year hence

Ke = 1.5 /20 +.2

Ke = 27.5%

Estimated value per share = 1.8 /( .275-.2)

= $24

Thank you.

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