Everest Inc. is presently enjoying relatively high growth because of a surge in

Question

Everest Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 28% for the next 2 years, 18.00% in year 3 and 4 and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6.25%. The company’s last dividend was $1.00, its beta is 1.75, the market risk premium is 6.55%, and the risk-free rate is 4.50%. What is the current price of the common stock?

Explanation / Answer

Cost of Equity = Risk free rate + Market Risk Premium *Beta =0.045+0.0655*1.75 = 0.15875 =15.875% Market rate of return = Risk free rate+ market risk premium =4.50+6.55 =11.05% Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Dividend 1 1.028 1.316 1.553 1.832 Stock Price at the end of Year 5 will be = Dividend*(1+Growth rate )/(cost of equity-rate of dividend growth)=(1.832*1.0625/(0.15875-0.0625) 20.223 Discount factor at 15.875% rate 1 0.863 0.745 0.643 0.555 0.479 PV of dividends and share price 1 0.887163 0.979994 0.997966 1.016268 9.680479 Total Of PV         14.56 So current price of stock = $14.56

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