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Renata Inc. is presently enjoying relatively high growth because of a surge in the demand for...

  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 (rs) is 12%. What is the best estimate of the current stock price?.

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

Solutions

Expert Solution

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

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