Question

Consider an all-equity firm with 125,000 shares outstanding. Assume that EBIT=800,000 and that EBIT will remain constant, the firm pays out all profits (EPS = dividends per share) as dividends, and that its tax rate is 40%. If the firm’s beta is 1.1, the risk-free rate is 4%, and the market risk premium is 6%, what is the firm’s stock price according to the dividend growth model?

Round your answer to the nearest cent.

Answer 1

EBIT	$            800,000
Interest	$                     -	(Since all equity firm)
EBT	$            800,000
Tax @ 40%	$          (320,000)
Earning after tax	$            480,000
Dividend distribution	$            480,000	(Since there is no retention)
No of shares	125,000
Dividend per share	480000/125000
Dividend per share	$                  3.84
Risk free rate	4%
Market risk premium	6%
Beta	1.1
Cost of equity=	Risk free rate + Beta * Market risk premium
Cost of equity=	4%+1.1*6%
Cost of equity=	10.60%
Current Dividend	£                  3.84
Rate of return	10.60%
Growth Rate	0.00%	(Since there is no retention, there will be no growth)
Share Price	=Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price	=3.84*(1+0)/(0.106-0)
Share Price	£                36.23