Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because

Question

3 years ago

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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 in 10 years 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?

Business

2 answers:

murzikaleks [220] · Answer 1 · 2022-05-31T11:16:29+03:00

Answer:

Ans. The current price of the stock is $135.13

Explanation:

Hi, first, we need to find the price of the stock in year 9, since in year 10 is when the company starts to pay dividends. I know it could sound weird, but due the nature of the following formula, all future cash flows are brought 1 period before the first payment, in our case, if the first dividend is going to be paid in year 10, all the future cash flows of the share (future dividends) are going to be brought to year 9. The formula as follows.

$PresentValue_{(9)} =\frac{Dividend(yr10)(1+GrowthRate)}{(Return-GrowthRate)}$

Things should look like this

$PresentValue_{(9)} =\frac{14*(1+0.06)}{(0.125-0.06)} =228.31$

So the present Value (in year 9) is $228.31, but we need it in the present, therefore, we have to use another formula to bring this value to present value, given the required rate of return.

$Present Value=\frac{FutureValue}{(1+Return)^{n} }$