Summit Systems has an equity cost of capital of 11.5%, will pay a dividend of $1
ID: 2766357 • Letter: S
Question
Summit Systems has an equity cost of capital of 11.5%, will pay a dividend of $1.25 in one year, and its dividends had been expected to grow by 6% per year. You read in the paper that Summit Systems has revised its growth prospects and now expects its dividends to grow at a rate of 4.0% per year forever.
A. What is the drop in value of a share of Summit Systems stock based on this information?
B. If you tried to sell your Summit Systems stock after reading this news, what price would you be likely to get, why?
Explanation / Answer
Value of stock with growth rate at 6%
Value of Stock = 1.25/(1.115)^1 + 1.25 (1+.06)/ (0.115-0.06)/(1.115)^2
18.37
Growth rate of 4%
Value of Stock = 1.25/(1.115)^1 + 1.25 (1+.04)/ (0.115-0.04)/(1.115)^2
15.06
Thus stock price drop by = $ 18.37 - $ 15.06 = $ 3.31
B After reading the news it is expected to fetch price of $ 15.06 as the price has already been discounted once it is in news
Cost of Equity (k) 11.50% D1 1.25 growth rate of dividend (g) 6% new growth rate (g1) 4%Related Questions
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