Mack Industries just paid a dividend of $1.00 per share (i.e., D0 = $1.00). Anal

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. First calculate the current stock price using Excel. If the target price of the company's stock is $30.00, what should the expected stable constant growth rate after two years?

Explanation / Answer

Expected return R = Rf + MRP x beta

                                  = 5% + 7% x 2

                                      = 19%

Dn =D(n-1) x (1+g)^n

D1 = 1 x (1+0.30)

       = $1.30

D2 = 1.30 x (1+0.20)

      = $1.56

P2= D2 x (1+g)/(R-g)

     = 1.56 x (1+0.05)/(0.19-0.05)

     = 1.638/ 0.14

     = $11.70

Current stock price would be the PV of future dividend and prices:

Year

Cash flow

PV factor 19%

PV

1

1.3

0.840336134

1.092437

2

1.56

0.706164819

1.101617

2

11.7

0.706164819

8.262128

$10.46

Therefore, current stock price would be $10.46.

Year

Cash flow

PV factor 19%

PV

1

1.3

0.840336134

1.092437

2

1.56

0.706164819

1.101617

2

11.7

0.706164819

8.262128

$10.46

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