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In: Finance

Boom and Fall (B&F) expects to grow its business in the first 3 years and then...

Boom and Fall (B&F) expects to grow its business in the first 3 years and then the business expects the growth to decline after. The company just paid its annual dividend of $1 per share and is planning to increase its annual dividend by 10% for the next 3 years, and then the dividend will decline at an annual rate of 4% forever.

What is the value of B&F stock in one year if the required return is 12%?

What would be the impact on B&F stock price if the business growth will not decline after 3 years, therefore management would maintain the same dividend as that of year 3? Explain.

Solutions

Expert Solution

Price = PV of CFs from it.

P3 = D4 / [ Ke - g ]

D4 - Div after 4 Years

P3 = Price after 3 Years

Ke - required Rate

g - Growth Rate

Div Calculation:

Year Particulars CF Formula Calculation
1 D1 $      1.10 D0( 1 + g) 1*1.1
2 D2 $      1.21 D1( 1 + g) 1.1*1.1
3 D3 $      1.33 D2( 1 + g) 1.21*1.1
4 D4 $      1.28 D3( 1 + g) 1.331*0.96

P3 = $ 1.28 / [ 12% - ( -4% ) ]

= $ 1.28 / [ 125 + 4% ]

= $ 1.28 / 16%

= $ 7.99

Price Today:

Year Particulars CF PVF @12% Disc CF
1 D1 $      1.10     0.8929 $      0.98
2 D2 $      1.21     0.7972 $      0.96
3 D3 $      1.33     0.7118 $      0.95
3 P3 $      7.99     0.7118 $      5.68
Price Today: $      8.58

Part B:

If no Growth Rate after 3 Years:

P3 = D4 / Ke

= $ 1.331 / 12%

= $ 11.09

P0:

Year Particulars CF PVF @12% Disc CF
1 D1 $      1.10     0.8929 $      0.98
2 D2 $      1.21     0.7972 $      0.96
3 D3 $      1.33     0.7118 $      0.95
3 P3 $   11.09     0.7118 $      7.89
Price Today: $   10.79

jeff jeffy answered 2 years ago
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