Question
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 |
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