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Power Inc. is presently enjoying relatively high growth because of a surge in the demand for...

Power 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 22% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock? $26.57 $32.69 $28.97 $23.39 $27.37

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Answer #1

Last Dividend, D0 = $1.25

Growth for next 4 years is 22% and 0% thereafter.

D1 = $1.2500 * 1.22 = $1.5250
D2 = $1.5250 * 1.22 = $1.8605
D3 = $1.8605 * 1.22 = $2.2698
D4 = $2.2698 * 1.22 = $2.7692

Required Return, rs = Risk-free Rate + Beta * Market Risk Premium
Required Return, rs = 3.00% + 1.20 * 5.50%
Required Return, rs = 9.60%

P3 = D4 / rs
P3 = $2.7692 / 0.0960
P3 = $28.8458

P0 = $1.525/1.096 + $1.8605/1.096^2 + $2.2698/1.096^3 + $28.8458/1.096^3
P0 = $26.57

So, current stock price is $26.57

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