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A young start-up company needs to plow back its earnings to fuel growth
A young start-up company needs to plow back its earnings to fuel growth. The company will pay no dividends on its stock until it pays its first dividend of $15 per share 11 years from today. Thereafter, it will increase the dividend by 6 percent per year. If the required return on this stock is 12 percent, what is the current share price? Enter your answer as dollars with 2 digits to the right of the decimal point in the box shown below.
Expert Solution
Sol:
First Dividend paid (Dn) = $15 (11 years from today)
Dividend growth rate (G) = 6% per year thereafter
Requireed rate of return (r) = 12%
To determine current share price (PV) of the share first we have to find stock price in year 10 (Pn):
Pn = Dn / (r - G)
P10 = 15 / (12% - 6%)
P10 = 15 / 6%
P10 = 250
Now Present value (P0) of stock = P10 / (1 + r)^n
P0 = 250 / (1 + 12%)^10
P0 = 250 / (1.12)^10
P0 = 250 / 3.1058 = $80.49
Therefore current share price (PV) of the share will be $80.49
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