booiat no equbnm price can be produced. 6. A stock, which currently does not pay

Question

booiat no equbnm price can be produced. 6. A stock, which currently does not pay a dividend, is expected to pay its first dividend of $1.00 per share in five years (D5 $1.00). After the dividend is established, it is expected to grow at an annual rate of 25 percent per year for the following three years (D8 = $1.953125) and then grow at a constant rate of 5 percent per year thereafter. Assume that the risk-free rate is 5.5 percent, the market risk premium is 4 percent, and that the stock's beta is 1.2. What is the expected price of the stock today? $20.65

Explanation / Answer

First of all let's calculate cost of equity

Ke= Rf+b(Rm-Rf)

Rf= risk free return

Rm= risk premium

b= beta

Ke= 5.5%+1.2(4%)

5.5%4.8%

=10.3%

Statement showing Price of share

P8 = D8(1+g) / Ke-g

=1.953(1.05)/10.3%-5%

=2.05065/5.3%

= 38.69$

Year Dividend PVIF @ 10.3% PV 1 0.9066 2 0.8220 3 0.7452 4 0.6756 5 1.000 0.6125 0.612523 6 1.250 0.5553 0.694156 7 1.563 0.5035 0.786668 8 1.953 0.4565 0.891509 P8 38.690 0.4565 17.66016 Price of share today 20.645

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