Question

Brushy Mountain Mining Company’s coal reserves are being depleted, so its sales are falling. Also, environmental costs increase each year, so its costs are rising. As a result, the company’s earnings and dividends are declining at the constant rate of 4% per year. If D0 = $6 and rs = 14%, what is the estimated value of Brushy Mountain’s stock?

Answer 1

Answer:

$32

Explanation:

Use dividend discount model (DDM) to calculate the price of the stock;

Price(P0) = D1/(rs - g)

whereby,

P0= Current price or current value of stock

D1 = Next year's expected dividend

rs = required rate of return

g = expected dividend growth rate (which is declining, so -0.04)

D1 = D0(1+g)

D1 = $6(1+-0.04) = $6 * 0.96 = $5.76

P0 = 5.76/(0.14 +0.04)

P0 = 32

Therefore, the value of Brushy Mountain’s stock is $32