Everest Inc. is presently enjoying relatively high growth because of a surge in
ID: 2820696 • Letter: E
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 34% for the next 2 years, 21.45% in year 3 and 4 and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6.50%. The company’s last dividend was $1.75, its beta is 1.15, the market risk premium is 9.70%, and the risk-free rate is 5.00%. What is the current price of the common stock? Round your answer to two decimal places.
Explanation / Answer
Current price of common stock
The formula for Dividend valuation model is
P0 = D1/(Ke-g)
Where,
Ke= Cost of Capital
G= Growth rate
D1 = Dividend at the end of year 1
On the basis of the information given
Ke= Risk free rate+ Beta(Market risk premium)
= 5+1.15*9.70=5+11.155= 16.155%
On the basis of the information given, the following projection can be made
Year
Dividend per share(DPS)($)
PVF @ 16.155%
PV of DPS($)
1
1.75*134%
=2.3450
0.8609
2.0188
2
2.345*134%
=3.1423
0.7412
2.3291
3
3.1423*121.45%
=3.8163
0.6381
2.4352
4
3.8163*121.45%
=4.6349
0.5493
2.5460
5
4.6349*106.50%
=4.9362
0.4729
2.3343
11.6634
After Year5, the perpetuity value assuming 6.5% constant annual growth is:
D6 = 4.9362*106.50% =$ 5.2571
Therefore Price (P5) at the end of 5th year= $ 5.2571/ 0.16155-0.0650
= $ 5.2571/ 0.09655 = $ 54.4495
This must be discounted back to the present value using the 5 year discount factor
Present value of P5 ($ 54.4495*0.4729) = $ 25.7492
Add: PV of Dividends year1 to year5= $ 11.6634
Current market price per share= $ 37.4126 say $31.41(Rounded)
Year
Dividend per share(DPS)($)
PVF @ 16.155%
PV of DPS($)
1
1.75*134%
=2.3450
0.8609
2.0188
2
2.345*134%
=3.1423
0.7412
2.3291
3
3.1423*121.45%
=3.8163
0.6381
2.4352
4
3.8163*121.45%
=4.6349
0.5493
2.5460
5
4.6349*106.50%
=4.9362
0.4729
2.3343
11.6634
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