Sun Corp. is thinking of changing their business model. Currently their beta is

Question

Sun Corp. is thinking of changing their business model. Currently their beta is 2 and the last dividend paid (yesterday) was $2.00. The growth rate of the dividend is constant at 3. If they change their business model, they believe that they can increase their growth rate of the firm and dividend to 5%( constant). They obviously want to increase this groth rate without sacrificing their current stock price. Currenlty in the risk free rate is 5%, market return is 10% and they expect them to remain the same in the future. What is Sun Corp's current stock price before the changes to the business model?

Explanation / Answer

Expected return = Rf+×Rp

Rf is risk free return

Rp is risk premium

= 5%+2×(10%-5%)

= 15%

Stock price = D1÷(r-g)

D1 is next expected dividend

r is cost of common stock

g is growth rate

= $2×(1+3%)÷(15%-3%)

= $17.17

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