As companies evolve, certain factors can drive sudden growth. This may lead to a

Question

As companies evolve, certain factors can drive sudden growth. This may lead to a period of nonconstant, or variable, growth. This would cause the expected growth rate to increase or decrease, thereby affecting the valuation model For companies in such situations, you would refer to the variable, or nonconstant, growth model for the valuation of the company's stock. Consider the case of Portman Industries: Portman Industries just paid a dividend of $3.60 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 20.00% over the next year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 4.00% per year. The risk-free rate (Rr) is 5.00%, the market risk premium (RPM) is 6.00%, and Portman's beta is 1.70 Term Value Dividends one year from now (D1) Horizon value (P1) Intrinsic value of Portman's stock Assuming that the market is in equilibrium, use the information just given to complete the table What is the expected dividend yield for Portman's stock today? 12.41% 10.77% Q 8.96% 11.20% Now let's apply the results of your calculations to the following situation: Portman has 1,000,000 shares outstanding, and Judy Davis, an investor, holds 15,000 shares at the current price (computed above). Suppose Portman is considering issuing 125,000 new shares at a price of $32.78 per share. If the new shares are sold to outside investors, by how much will Judy's investment in Portman Industries be diluted on a per-share basis? O $1.34 per share O $0.54 per share O $0.79 per share O $0.64 per share Thus, Judy's investment will be diluted, and Judy will experience a total 0

Explanation / Answer

cost of equity=risk free+beta*market risk premium=5%+1.7*6%=15.2%
D1=3.6*1.2=4.32
P1=4.32*1.04/(15.2%-4%)=40.11428571
Intrinsic value=4.32/1.152+40.11428571/1.152=38.57142857

Dividend yield=4.32/38.57142857=11.20%

Portman's value=1000000*38.57142857
Judy's value=15000*38.57142857
Total value of Portman after equity issue=(1000000*38.57142857+125000*32.78)/(1000000+125000)=37.92793651

Dilution on per share basis=38.57142857-37.92793651=$0.64 per share

Judy will experience a total loss of 0.64*15000=9600

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