A major pharmaceutical company is close to finishing developing a vaccine for a new virus that...

A major pharmaceutical company is close to finishing developing a vaccine for a new virus that is spreading rapidly around the world. The company expects to pay its first dividend of $5 per-share a year from now (year 1), and is projecting dividends to grow at 10% p.a. for the following four years. However, from that point (i.e.,from year five) it is expected that the need for vaccination will decline, and consequently dividends are expected to decline by 8% p.a. thereafter. How much should you be willing to pay for a share of stock in this pharmaceutical company if you require a 7% p.a. rate of return?

Expert Solution

D1=5

D2=(5*1.1)=5.5

D3=(5.5*1.1)=6.05

D4=(6.05*1.1)=6.655

D5=(6.655*1.1)=7.3205

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)

=(7.3205*(1-0.08)/(0.07-(0.08)

=6.73486/0.15

=44.8990667

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=5/1.07+5.5/1.07^2+6.05/1.07^3+6.655/1.07^4+7.3205/1.07^5+44.8990667/1.07^5

=$56.72(Approx)

jeff jeffy answered 2 years ago

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