Black Hole Corp (BHC) just reported earnings per share (EPS) today of $7.00 and
ID: 2785152 • Letter: B
Question
Black Hole Corp (BHC) just reported earnings per share (EPS) today of $7.00 and is expected to grow its earnings by 25% per year for the next three years. After which, their earnings growth will settle down to 3% per year. The management team of BHC just announced that the firm will never pay a single dividend to any of its shareholders . . . ever. Governance experts claim that management is fully entrenched and there is no chance of a successful takeover. If investors demand a 12% return, what is the price of BHC's stock?
Explanation / Answer
Stock price is the present value of future EPS
C0 = 7
C1 = 7*1.25
C2 = 7*1.25^2
C3 = 7*1.25^3
C4 = 7*1.25^3*1.03
According to Dividend discount model,
P0 = C1/(R-g)
R - required rate
g - growth rate
P3 = C4/(R-g) = 7*1.25^3*1.03/(12%-3%) = 156.47
To find the present value, discount the future values
P0 = 7*1.25/(1+0.12) + 7*1.25^2/(1+0.12)^2 + 7*1.25^3/(1+0.12)^3 + 156.47/(1+0.12)^3 = 137.63
Stock price = $137.63
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