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Problem 3 MGMT 61000 Final Exam; Lynn Turner- PUID-00311127131 Pricing stock for Initial Public Offering Ten...
Problem 3 MGMT 61000 Final Exam; Lynn Turner- PUID-00311127131 Pricing stock for Initial Public Offering Ten years ago, Video Toys began manufacturing and selling coin-operated arcade games. The company has done well in that dividends have been growing at a 15% compounded annual rate for the past five years. The last Dividend paid, which was just yesterday, was $1.50 per share. The annual growth rate of 15% is expected to be maintained for the next 3 years, after which dividends are expected to grow at half the rate for 1 year. Beyond that time, Video Toys' dividends are expected to grow at 5% per year. A. If the company was going to go public today, what would be the price per share that you think the public offer price should be if your required rate of return on equity is 18%? B. The company has a total of 10,000,000 shares. 5 million shares will be sold in the IPO and 5 million shares will remain in the possession of the founder, Mr. Strong. What is the total value of the company's equity after the IPO?
Solutions
Expert Solution
| A) | The price per share would be the PV of the expected dividends | |||||
| discounted at the required rate of return of 18%. | ||||||
| The expected dividends for the first 4 years and their PV are: | ||||||
| Year | Growth rate | Expected Dividends | PVIF at 18% | PV at 18% | ||
| 1 | 15.00% | 1.73 | 0.84746 | $ 1.47 | ||
| 2 | 15.00% | 1.99 | 0.71818 | $ 1.43 | ||
| 3 | 15.00% | 2.29 | 0.60863 | $ 1.39 | ||
| 4 | 7.50% | 2.46 | 0.51579 | $ 1.27 | ||
| PV of dividends for the 1st four years = | $ 5.56 | |||||
| Continuing value of dividends = 2.46*1.05/(0.18-0.05) = | $ 19.87 | |||||
| PV of continuing value = 19.87*0.51579 = | $ 10.25 | |||||
| Price for the IPO | $ 15.81 | |||||
| B) | Total value of the company's equity after IPO = 10,000,000*15.81 = | $ 15,81,00,000 | ||||
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