Question

Pacific Healthcare is an investor-owned hospital chain that owns and operates nine hospitals in Washington, Oregon, and Northern California. You are a recent graduate of a prominent healthcare administration program and have just been hired by Washington Medical Center, Pacific’s largest hospital. Like all new management personnel, you must undergo three months of intensive training at the system level before joining the hospital. You begin by examining Pacific’s annual report to get some basic financial data. You search Yahoo! Finance, CNNMoney, Bloomberg, and MSN Money for current market data as well as analysts’ forecasts for Pacific Healthcare and the market. You discover that Pacific’s stock is currently selling for $8 per share, current dividend is $0.48 per share (paid on December 31, 2019), and the beta coefficient is 1.2. In addition, you learn that the yield on long-term Treasury bonds is 5.0 percent and that a market return of 11 percent is expected. Most analysts forecast that Pacific will grow about 10 percent per year for the next five years (2020-2024) and 4 percent per year thereafter (2025 and beyond). Based on these growth forecasts, you assembled the forecast dividends per share, as shown in the below exhibit. -

Historical Year/Dividends per share 2014/$0.215; 2015/$0.324; 2016/$0.353; 2017/$0.362; 2018/$0.391; 2019/$0.480

Forecast Year/Dividend per Share 2020/$0.528; 2021/$0.581; 2022/$0.639; 2023/$0.703; 2024/$0.773; 2025/$0.804; 2026/$0.836

Excel Problem (Answers to highlighted cells): If investors estimate that Pacific Healthcare will grow about 10 percent per year for the next five years (2020-2024), what constant growth rate (2025+) are they using to price the stock? (Hint: what constant growth rate (2025+) produces an actual December 31, 2019 stock price of $8?)

	Year	D(0)	Growth	E(D1)
2019	0			$0.48
2020	1	$0.48	10%	$0.53
2021	2	$0.53	10%	$0.58
2022	3	$0.58	10%	$0.64
2023	4	$0.64	10%	$0.70
2024	5	$0.70	10%	$0.77
2025	6	$0.77		$0.77
	2020	2021	2022	2023	2024	PV
Year 1-5 dividends	$0.53	$0.58	$0.64	$0.70	$0.77
Year 6+ dividends
Actual stock price on December 31, 2019
Hint: Actual stock price on December 31, 2019 should equal $8

Answer 1

Constant growth rate (2025+) are they using to price the stock = 4.30%

Working:

First we calculate required rate of return:

Using CAPM formula:

Required rate of return = Rf + Beta * (Rm - Rf) = 5% + 1.2 * (11% - 5%) = 12.20%

Above excel with 'show formula' is as follows: