Estimate the current value of Morris Industries\' common stock, P0 = ? Assume Th

ID: 2816944 • Letter: E

Question

Estimate the current value of Morris Industries' common stock, P0 = ?

Assume

The most recent annual dividend payment of Morris Industries was $4 per share.

The firm's financial manager expects that these dividends will increase at an 8% annual rate over the next 3 years.

At the end of the 3 years the firm's mature product line is expected to result in a slowing of the dividend growth rate to 5% per year forever.

The firm's required return (r) is 12%.

Add the PV of the initial dividend stream to the PV of the stock price at the end of the initial growth period:

P0 = $? + $? = $64.98

How to do this problem? What formula to use?

Recent Dividend, D0 = $4

Growth rate for next 3 years is 8%, followed by a constant growth rate (g) of 5%

D1 = $4.0000 * 1.08 = $4.3200
D2 = $4.3200 * 1.08 = $4.6656
D3 = $4.6656 * 1.08 = $5.0388
D4 = $5.0388 * 1.05 = $5.2907

Required Return, r = 12%

P3 = D4 / (r - g)
P3 = $5.2907 / (0.12 - 0.05)
P3 = $75.5814

PV of Initial Dividend = $4.32/1.12 + $4.6656/1.12^2 + $5.0388/1.12^3
PV of Initial Dividend = $11.16

PV of Stock Price at the end of initial growth period = $75.5814/1.12^3
PV of Stock Price at the end of initial growth period = $53.80

Current Price = PV of Initial Dividend + PV of Stock Price at the end of initial growth period
Current Price = $11.16 + $53.80
Current Price = $64.96

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