Question

1. Renata Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 22% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D₀, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?
2. The Best Company's last dividend was $1.75. Its dividend growth rate is expected to be constant at 24% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (r_s) is 12%. What is the best estimate of the current stock price?.

posted previously 1 but never went through please show work for both

Answer 1

1

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

Expected return% = 3 + 1.2 * (5.5)

Expected return% = 9.6

	Required rate=	9.60%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	1.25	22.00%	1.525		1.525	1.096	1.3914
2	1.525	22.00%	1.8605		1.8605	1.201216	1.54885
3	1.8605	22.00%	2.26981		2.26981	1.316532736	1.72408
4	2.26981	22.00%	2.7691682	28.846	31.6151682	1.442919879	21.91055
	Long term growth rate (given)=	0.00%			Value of Stock =	Sum of discounted value =	26.57

Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 4 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

2

	Required rate=	12.00%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	1.75	24.00%	2.17		2.17	1.12	1.9375
2	2.17	24.00%	2.6908	47.537	50.2278	1.2544	40.04129
	Long term growth rate (given)=	6.00%			Value of Stock =	Sum of discounted value =	41.98

Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 2 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor