Question

Bobs Group, a firm that specializes in the design and manufacturing of aircraft components, has 150 million shares outstanding and analysts expect Bobs to have earnings of $450 million this coming year (t=1). Bobs plans to pay out 55% of its earnings in dividends and they expect to use an additional 15% of their earnings to repurchase shares. Bob's equity cost of capital is 11%. Its earnings are expected to grow at a rate of 3% per year and these payout rates are expected to remain constant. What is the value of one share of Bob's stock today? 


a. $26.25 b. $20.63 c. $5.63 d. $2.10 e. $37.50 f. None of the above answers is within $0.25 of the value of one NORDAM share. 


Answer 1

The expected earnings of Bobs to this coming year (t=1) =$450 million

Expected Dividend payout = 55% of the expected earnings

= 55% *$450 million

= $247.50 million

Therefore expected dividend per share, D1 = expected Dividend payout/ number of shares outstanding

Where, number of shares outstanding = 150 million

Therefore,

Therefore expected dividend per share, D1 = $247.50 million/ 150 million

= $1.65 per share

Now,

The value of one share of Bob's stock today, P0 = D1/ (k – g)

Where

P0 = the current stock price =?

D1 = dividend for next year = $ 1.65 per share

k = required rate of return or equity cost of capita = 11%

g = growth rate of dividends (constant) = 3%

Therefore

The value of one share of Bob's stock today, P0 = $ 1.65 / (0.11 – 0.03) = $20.625 or $20.63

Therefore correct answer is option b. $20.63