Question

Sinclair​ Pharmaceuticals, a small drug​ company, develops a vaccine that will protect against Helicobacter pylori​,a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $ 1.25 per share before the development of the vaccine and are expected to grow by​ 40% per year for the next three years. After this​ time, it is expected growth will drop to 3% and stay there for the expected future. Four years from now Sinclair will pay dividends that are​ 75% of its earnings. If its equity cost of capital is 10%,

what is the value of a share of Sinclair Pharmaceuticals​ today?

37.85

22.75

28.44

36.97

Answer 1

The Correct Option is $28.44

Calculations And Explanations are given below

First of all we have calculate EPS and DPS of each given Years in the following table

Years	EPS	DPS
1	1.25*1.4   =1.75	0
2	1.75*1.4 =2.45	0
3	2.45*1.4 =3.43	0
4	3.43*1.03 =3.5329	3.5329*.75=2.6496 (i.e. D4=2.6496)

Since in the first stage of three years dividend is not paid so there there will be 0 cashflows in first three years.

Calculation of value of share at the end third year

Value at the end of third year= D4/(r-g)

Where

                D4= $2.6496

                r = 10% (Cost of capital)

                g = 3% ( growth rate after three years)

So the Value at the end of third year = $2.6496/(.10-.03)

                                                                                = 2.6496/.07

                                                                                = $ 37.85

Since it is value of share after 3 years so we have discout it by PVIF (10%, 3yrs) so that we will get value at beginning of first year

    i.e. Current value of share = Value after 3years/(r+1)3

                                                                                                = $37.85/(.10+1)3

                                                                                                = $37.85/(1.10)3

                                                                                                = $37.85/1.331

                                                                = $ 28.44

Hence the value of share is $ 28.44