Question
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MGM Enterprises expects earnings and dividends to grow at a rate of 25% for the next...
MGM Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after that the growth rate in earnings and dividends will fall 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?
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Expert Solution
| 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 | 25.00% | 1.5625 | 1.5625 | 1.096 | 1.4256 | |
| 2 | 1.5625 | 25.00% | 1.953125 | 1.953125 | 1.201216 | 1.62596 | |
| 3 | 1.953125 | 25.00% | 2.44140625 | 2.44140625 | 1.316532736 | 1.85442 | |
| 4 | 2.44140625 | 25.00% | 3.051757813 | 31.789 | 34.84075781 | 1.442919879 | 24.14601 |
| Long term growth rate (given)= | 0.00% | Value of Stock = | Sum of discounted value = | 29.05 |
| 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 | |||
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