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Corporation Y has never made any dividend payments. You project the following dividend payments in the...

Corporation Y has never made any dividend payments. You project the following dividend payments in the next 5 years:

t (years) Dividend

1 $0.00

2 $0.00

3 $2.00

4 $2.50

5 $3.00

You assume that beginning at the end of year 5, the dividends will grow at the sustainable growth rate. The firms ROE is 15% and its plowback ratio 30%. The cost of equity capital is 10%. Please, find the theoretical value of a single share of their common stock.

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Answer #1

Stock Price = PV(Dividends) + PV(Horizon Value)

Sustainable Growth Rate = Plowback Ratio(ROE)

Sustainable Growth Rate = 0.30(0.15) = 4.50%

Cost of Equity = 10%

Stock Price = 2/(1.10)3 + 2.50/(1.10)4 + 3/(1.10)5 + 3(1.045)/(0.10 - 0.045)(1.10)5

Stock Price = $40.47

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