Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 10 years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $6 per share 11 years from today and will increase the dividend by 8 percent per year thereafter.

  

If the required return on this stock is 13 percent, what is the current share price?

Multiple Choice

• $35.35

• $36.41

• $33.58

• $37.12

• $31.28

Answer 1

Stock Price :
The price is a reflection of the company's value – what the public is willing to pay for a piece of the company. It is nothing but present value of cash flows ( Div & Sale Price of Stock at future date) from it.
P10 = D11 / [ Ke - g ]

P10 - Price after 10 Years

D11 - Div after 11 Years

Ke - required Ret

g - Growth Rate

= $ 6.00 / [ 13% - 8% ]

= $ 6.00 / 5%

= $ 120.00

Price Today:

Present Value:

Present value is current value of Future cash flows discounted at specified discount Rate.

PV = FV / (1+r)^n
Where r is Int rate per period
n - No. of periods

As dividends for 10 years is 0. Hence igored and considered price after 10 years alone.

Particulars	Amount
Future Value	$                 120.00
Int Rate	13.0000%
Periods	10

Present Value = Future Value / ( 1 + r )^n
= $ 120 / ( 1 + 0.13 ) ^ 10
= $ 120 / ( 1.13 ) ^ 10
= $ 120 / 3.3946
= $ 35.35

Value of stock today is $ 35.35