Mack Industries just paid a dividend of $1.00 per share (i.e., D 0 = $1.00). Ana

Question

Mack Industries just paid a dividend of $1.00 per share (i.e., D0 = $1.00). Analysts expect the company's dividend to grow 30 percent this year, and 20 percent in second year. After two years the dividend is expected to grow at a constant rate of 5 percent. The risk free rate is 5% and expected market risk premium is 7% and the firm is twice as risky as market. If the current price of the company's stock is $25.00, what is the expected stable constant growth rate after two years?     (8 points)

Hint: “Goal Seek” from “What-If Analysis”

Explanation / Answer

As per CAPM

Required Rate of Return = Risk free rate + market risk premium *beta

Required Rate of Return = 5 + 7*2

Required Rate of Return = 19%

Stock Price = D1/(1+re) + (D2/(Re-g))/(1+re)

25 = 1*1.30/1.19 + (1*1.3*1.2/(19%-g))/1.19

25*1.19 = 1.30 + 1.56/(19%-g)

1.56/(19%-g) = 29.75-1.30

(19%-g) = 1.56/28.45

g = 19% - 5.48%

g = 13.52 %

Answer

Expected stable constant growth rate after two years = 13.52 %

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