Question

In: Finance

C. A company does not pay any dividends for 5 years. Then, it starts paying $6...

C. A company does not pay any dividends for 5 years. Then, it starts paying $6 in year 6. This continues perpetually. What is the market price of the stock?

The bond rate , market premium and beta are .02, .06 and 1.8 respectively.

Solutions

Expert Solution

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 2 + 1.8 * (6)
Expected return% = 12.8
Required rate= 12.00%
Year Previous year dividend Dividend growth rate Dividend current year Horizon value Total Value Discount factor Discounted value
1 0 0.00% 0 0 1.12 0
2 0 0.00% 0 0 1.2544 0
3 0 0.00% 0 0 1.404928 0
4 0 0.00% 0 0 1.57351936 0
5 0 0.00% 0 0 1.762341683 0
6 0 0.00% 6 50 56 1.973822685 28.37
Long term growth rate (given)= 0.00% Value of Stock = Sum of discounted value = 28.37
Where
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 6 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

jeff jeffy answered 7 months ago
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