Question

XYZ Pharmaceutical, Inc. just got FDA approval for their new drug, Viagrina. The company has never paid a dividend, but they expect to pay one for the first time by the end of the year. The expected dividend is $3.00 per share and the company expects that dividend to increase at a rate of 20% for five years. After that, XYZ expects to see its dividend growth limited by the growth rate the US economy, which on average is 4.5% per year. If the required rate of return for other startup pharmaceutical companies like XYZ is 11%, what should be the fair price of XYZ’s stock today?

Answer 1

(A) Present Value of 5 Years Cash Flow
Year	Calculation	Div Amt	DF @ 11%	Discounted Div amt
D0		$         3.00
D1	= 3 + 20%	$         3.60	0.9009	$       3.24
D2	= 3.6 + 20%	$         4.32	0.8116	$       3.51
D3	= 4.32 + 20%	$         5.18	0.7312	$       3.79
D4	= 5.184 + 20%	$         6.22	0.6587	$       4.10
D5	= 6.22 + 20%	$         7.46	0.5935	$       4.43
			Total (A)	$    19.07
(B) Terminal Value i.e. Value still Perpituity
Po =	D / (Ke - g)
D6	= 7.46 + 4.5%
	7.505
TV	= 7.505 / (0.11 - 0.045)
	$            115.46
Present Value of terminal Value			= $115.46.23 X .5935
			$    68.53
Stock Price = (A) + (B)
	= 19.07 + 68.53
	$               87.60