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Homework answers / question archive / A financial analyst has been following "ABC" Corporation, a new unusual growth company
A financial analyst has been following "ABC" Corporation, a new unusual growth company. According to his observations, he had the following information: • He expects that the current risk-free rate is 6.25%, • the market risk premium is 5%, and that the • "ABC" Corporation beta is 1.75. • The current earnings per share (EPS) is $2.50. • The analyst estimates that the company's dividends will grow at a rate of 25% this year, 20% next year, and 15% the following year. After three years the dividend is expected to grow at a constant rate of 7% a year, • The company is expected to maintain its current payout policy, which mandated that divides should be equal to 40% of the value of the EPS Based on the above-given information, what is the current price of the stock?
Ke = Rf + Beta (Market Premium) = 6.25 + 1.75 (5) = 15%
Value of stock = PV of all dividends which include high growth period (Phase 1) and constant growth period (Phase 2)
Phase 1
Current Dividend: $ 2.5 (EPS) * 40% (payout %) = $ 1
| Year | Dividend growth from last dividend | Dividend | PV factor @ 15% | PV (dividend * pv factor) |
| 0 | 0 | 1 | 0 | 0 |
| 1 | 0.25 | 1.25 | 0.869565 | 1.087 |
| 2 | 0.2 | 1.5 | 0.756144 | 1.134 |
| 3 | 0.15 | 1.725 | 0.657516 | 1.134 |
| Total of Phase 1 | 3.355 |
Phase 2
D4 = 1.725 * 1.07 (7% growth) = $ 1.84575
Value of stock at the end of 3rd year = $ 1.84575 / (15% - 7%) = $ 23.072
Present value of $ 23.072 = $ 23.072 / 1.15^3 = $ 15.17 (Value of Phase 2)
Price of stock = Phase 1 ($ 3.355) + Phase 2 ($ 15.17) = $ 18.525
