Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 9 years because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $15.75 per share 10 years from today and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13 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 stock price is $65.54

Step-by-step explanation:

Consider the provided information.

The company will then pay a dividend of $15.75 per share 10 years from today and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 13 percent,

Therefore, the value of next dividend is $15.75, and it will increase with the rate of 5% i.e growth rate = 5% = 0.05

The required rate is 13% = 0.13

Now calculate the stock price for the next 9 yr as shown:

$P_9=\frac{\text{Next dividend}}{\text{Required rate-Growth rate}}$

$P_9=\frac{\ 15.75}{0.13-0.05}$

$P_9=\frac{\ 15.75}{0.08}$

$P_9=\ 196.875$

Now calculate the current stock price as shown:

$P_0=\frac{P_9}{(1+\text{Required rate of return})^9}$

$P_0=\frac{\ 196.875}{(1+0.13)^9}$

$P_0=\frac{\ 196.875}{(1.13)^9}= 65.54$

Therefore, the current stock price is $65.54