Question

7. Constant growth rates One of the most important components of stock valuation is a firm’s estimated growth rate. Financial statements provide the information needed to estimate the growth rate. Consider this case: Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant growth rate that he should use while valuing Pan Asia Mining Co. Robert has the following information available: • Pan Asia Mining Co.’s stock (Ticker: PAMC) is trading at $13.75. • The company’s stock is expected to pay a year-end dividend of $0.66 that is expected to grow at a certain rate. • The stock’s expected rate of return is 6.60%. Based on the information just given, what will be Robert’s forecast of PAMC’s growth rate?

Answer 1

Based on information given, Robert’s forecast of PAMC’s growth rate will be 11.4%.

Here, we are going to calculate Robert’s forecast of PAMC’s growth rate by using the information provided..

• The formula to be deployed is Price = Dividend in 1 year/(cost of equity - growth rate)

Given Information

Pan Asia Mining Co.’s stock is trading at $13.75

Expected year-end dividend = $0.66

Stock’s expected rate of return = 6.60%.

$13.75 = $0.66 / (6.60% - Growth rate)

$13.75 = $0.66 / (0.066 - Growth rate)

$13.75*((0.066 - Growth rate) = $0.66

$0.9075 - $13.75(Growth rate) = $0.66

$13.75(Growth rate) = $0.66 + $0.9075

Growth rate = $1.5675 / $13.75

Growth rate = 0.114

Growth rate = 11.4%

Therefore, Robert’s forecast of PAMC’s growth rate will be 11.4%.

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