Question

ABC company is expected to grow at the industry constant rate of 6% and its dividend yield is 7%. the company is as risky as the average firm in the industry, but it successfully completed some R&D work that leads to the expectation that its earnings and dividends will grow at a rate of 50% this year and 35% in the following year, after which growth return to the 6% industry average. if the last dividend was $1.00, what is the estimated value per share of ABC Company's stock?

Show all the work please.

Answer 1

Solution:-             

DPS0 = $1.00

Required return of security = 7% + 6% = 13%,

g1 = 50%

g2 = 35%

gn = 6%

DPS1=1.00*1.5

          =$1.50

DPS 2=1.50*1.35

     =$ 2.025

DPS 3=$2.025*1.06

   =$2.1465

As per dividend growth model,

PV of future cash flow at Y2=DPS3/(RR-g)

                                            =$2.1465/(0.13-0.06)

                                           = $30.66

Price of share at Y2 including dividend=$30.66+$2.1465

                                                               = $32.81

So estimated price of share at Y0=$1.50/(1+0.13)+$ 32.81/(1+0.13)^2

                                      =1.3274+25.69

                                      =$27.02