Question

Facebook has gone public by issuing equity. As an analyst for a bank, you've estimated that the company will have a Beta of 1.2. You know that Facebook just gave a dividend of $4.00 per share. You anticipate high growth of this dividend for the first few years. You predict that dividend will grow by 20% for three years. After that, you anticipate growth to be a more modest 5% per year. The risk-free rate is 2% and the average return of the market is 13%.

1. What is the expected return of Facebook’s stock?

2. What is the expected price TODAY of Facebook’s stock?

3. What is the dividend yield of the stock this year and next year (from t=0 to t=1 AND from t=1 to t=2)?

4. What is the expected price of the stock next year?

Answer 1

Required rate of return or expected return= Risk Free rate+Beta*Risk Premium=2%+1.2*(13%-2%)=15.20%

Now, dividend on 3rd year=4*(1+20%)^3=$6.912

Dividend on terminal 4th year= 3rd year dividend*(1+growth rate)/(Required rate of return-growth rate)=6.912*(1+5%)/(15.2%-5%)=$71.15

Year	Dividend	Present Value of dividend (Cash flow/1.152^year)
1	4.8	4.166666667
2	5.76	4.340277778
3	6.912	4.521122685
4	71.15294	40.40014654
	Total	53.42821367

Hence, Today's expected price of facebook stock =$53.42

Hence, dividend yield this year is 8.98% and for next year is 11.69%

Expected price for next year is $49.26