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Better Mousetraps has come out with an improved product, and the world is beating a path...

Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 18% per year for 4 years. By then, other firms will have copy technology, competition will drive down profit margins, and the sustainable growth rate will fall to 3%. The most recent annual dividend was DIV0=$1.2 per share

a)What are the expected values of (i) DIV1, (i) DIV2, (i) DIV3, (i) DIV4?

b)What is the expected stock price 4 years from now? The discount rate is 15%

c)What is the stock price today?

d)Find the dividend yield

e)What will next year’s stock price be?

f)What is the expected rate of return to an investor who buys the stock now and sells it in 1 year?

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Answer:

a. 

D(i+1) = Di*(1+Gi)^i  where Gi is the year i growth rate. 

D1 = 1.20 * (1+0.18) = 1.416

D2 = D1 * 1.18 = 1.67088 ; 
D3 = 1.97164 ; 
D4 = 2.32653

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b. 

D5 = D4 * (1+0.03) = 2.39633

P4 = D5/(k-g) =  2.39633/(0.15 - 0.03) = 19.9694

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c. What is the stock price today? 

"Stock Value = PV of Dividends"

P0 = D1/(1+k) + D2/(1+k)^2 + D3/(1+k)^3 + D4/(1+k)^4 + P4/(1+k)^4

P0 = 1.416/(1.15) + 1.67088/(1.15)^2 + 1.97164/(1.15)^3 + 2.32653/(1.15)^4 + 19.9694/(1.15)^4

P0 = 16.53885

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d. Find the expected dividend yield. 

Dividend yield = D1/P0 = 1.416/16.53885 = 0.0856 or 8.56%

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e. )What will next year’s stock price be?

Stock price in one year = 16.53885*(1+1.15)-1.416 = 17.60

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f. What is the expected rate of return to an investor who buys the
stock now and sells it in 1 year?

k = D1/P0 + G1 = 1.416/16.53885 + 0.18 = 0.2656 = 26.56%

jeff jeffy answered 1 year ago
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