Everest Inc. is presently enjoying relatively high growth because of a surge in

Question

Everest Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 20% for the next 2 years, 15% in year 3 and 4 and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6%. The company’s last dividend was $2, its beta is 2, the market risk premium is 9%, and the risk-free rate is 7%. What is the current price of the common stock?

Explanation / Answer

Required return=Risk free rate+Beta*market risk premium

=7+(2*9)=25%

D1=(2*1.2)=2.4

D2=(2.4*1.2)=2.88

D3=(2.88*1.15)=3.312

D4=(3.312*1.15)=3.8088

Value after year 4=(D4*Growth rate)/(Required return-Growth rate)

=(3.8088*1.06)/(0.25-0.06)

=$21.24909474

Hence current price=Future dividends*Present value of discounting factor(25%,time period)

=2.4/1.25+2.88/1.25^2+3.312/1.25^3+3.8088/1.25^4+$21.24909474/1.25^4

which is equal to

=$15.72(Approx).

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