Question

Everest Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 34% for the next 2 years, 21.45% in year 3 and 4 and after which competition will probably reduce the growth rate in earnings and dividends to constant growth rate of 6.50%. The company’s last dividend was $1.75, its beta is 1.15, the market risk premium is 9.70%, and the risk-free rate is 5.00%. What is the current price of the common stock? Round your answer to two decimal places.

Answer 1

Current price of common stock

The formula for Dividend valuation model is

P₀ = D₁/(K_e-g)

Where,

K_e= Cost of Capital

G= Growth rate

D₁ = Dividend at the end of year 1

On the basis of the information given

Ke= Risk free rate+ Beta(Market risk premium)

= 5+1.15*9.70=5+11.155= 16.155%

On the basis of the information given, the following projection can be made

Year	Dividend per share(DPS)($)	PVF @ 16.155%	PV of DPS($)
1	1.75*134% =2.3450	0.8609	2.0188
2	2.345*134% =3.1423	0.7412	2.3291
3	3.1423*121.45% =3.8163	0.6381	2.4352
4	3.8163*121.45% =4.6349	0.5493	2.5460
5	4.6349*106.50% =4.9362	0.4729	2.3343
			11.6634

After Year5, the perpetuity value assuming 6.5% constant annual growth is:

D₆ = 4.9362*106.50% =$ 5.2571

Therefore Price (P₅) at the end of 5^th year= $ 5.2571/ 0.16155-0.0650

= $ 5.2571/ 0.09655 = $ 54.4495

This must be discounted back to the present value using the 5 year discount factor

Present value of P₅ ($ 54.4495*0.4729) = $ 25.7492

Add: PV of Dividends year1 to year5= $ 11.6634

Current market price per share= $ 37.4126 say $31.41(Rounded)