PLEASE EXPLAIN IN DETAIL SHOW EACH STEP FOR EACH PART AND USED AND SHOE FORMULAS

Question

PLEASE EXPLAIN IN DETAIL SHOW EACH STEP FOR EACH PART AND USED AND SHOE FORMULAS

We have a common stock which has a dividend which grows at 100%for the first 1 year and 200% for the next 1 year. After that it rises more reasonably, but we only know it indirectly. Net profit margin, ATO and financial leverage are .02, 3 and 2 respectively. The dividend payout ratio is .4. The risk free rate, market rate and bheta unlevered is .04, .12 and 2.5 respectively. The tax rate debt and equity are 20%, $4 million and $16 million respectively. First, compute the price of the stock.

Explanation / Answer

Equity=16
Return on Equity=Net profit margin*ATO*Financial Levergae=2%*3*2=12%
Net Income=Equity*Return on Equity

Hence, Net Income=12%*16=1.92
Current Dividend=Net Income*Dividend Payout Ratio=0.4*1.92=0.768
Growth rate=Return on Equity*(1-dividend payout)=12%*(1-0.4)=7.2%

Beta levered=beta unlevered*(1+(1-t)*D/E)=2.5*(1+(1-20%)*4/16)=3
Hence, required return=4%+3*(12%-4%)=28%

So, Price of stock=0.768*(1+100%)/1.28+0.768*(1+100%)*(1+200%)/1.28^2+0.768*(1+100%)*(1+200%)*(1+7.2%)/((28%-7.2%)*1.28^2)
=18.50769

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