Question

Ceebros Builders is expanding very fast and is expected to grow at a rate of 25 percent for the next four years. The company recently paid a dividend of $3.60 but is not expected to pay any dividends for the next three years. In year 4, management expects to pay a $5 dividend and thereafter to increase the dividend at a constant rate of 6 percent. The required rate of return of such stocks is 20 percent. (9 points)

a. Calculate the present value of the dividends during the fast-growth period. (3 points)

b. What is the value of the stock at the end of the fast-growing period (P4)? (3 points)

c. What is the price of the stock today? (3 points)

Answer 1

a. The present value of the dividends during the fast-growth period = D4/(1 + r)^4

The present value of the dividends during the fast-growth period = 5/(1 + 0.20)^4

The present value of the dividends during the fast-growth period = $2.4112654321

b. P4 = D5/(r - g)

D5 = D4 * (1 + g)

D5 = 5 * (1 + 0.06)

D5 = 5.3

P4 = 5.3/(0.20 - 0.06)

P4 = $37.8571428571

c. P0 = P4/(1 + r)^4 + The present value of the dividends during the fast-growth period

P0 = 37.8571428571/(1 + 0.20)^4 + 2.4112654321

P0 = 18.2567239859 + 2.4112654321

P0 = $20.667989418