Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $14 per share 10 years from today and will increase the dividend by 6 percent per year thereafter. If the required return on this stock is 12.5 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

The current share price is $74.62.

Explanation:

The constant growth model of the DDM requires is used to estimate the fair price per share of a stock based on the expected dividends that it will pay in future when these dividends are growing at a constant rate. The formula for this model is,

Price today = D1 / r - g

Where,

D1 is the dividend in year 1

r is the required rate of return

g is the growth rate in dividends

However as the company will pay dividends from year 10. Thus, the D10 will 14.

The value of the stock at year 9 will be,

Price at year 9 = 14 / (0.125 - 0.06)

Price at year 9 = $215.38

We will discount this by the required rate of return to calculate the present value.

Present price per share = [(14 / (0.125 - 0.06)) / (1+0.125)^9]

Present prie per share = $74.617