A start-up will not pay any dividends for 3 years. At the end of the third year, it is expected to pay a dividend of $0.30. This dividend should then grow at a rate of 12% for 6 years, and at a reduced rate of 6% thereafter. The market required rate of return for similar high growth start-up companies is 16%. Estimate the price of the company's shares today.

Question

Tanya Knox

Business

24 May, 09:53

A start-up will not pay any dividends for 3 years. At the end of the third year, it is expected to pay a dividend of $0.30. This dividend should then grow at a rate of 12% for 6 years, and at a reduced rate of 6% thereafter. The market required rate of return for similar high growth start-up companies is 16%. Estimate the price of the company's shares today.

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Penelope Downs · Answer 1

The price of share at today is $1.724.

Explanation:

- First, calculate the present value of the estimated value of the dividend stream from end of Y3 to end of Y9 using growing annuity formula:

[0.3 / (0.16 - 0.12) ] x [ 1 - [ (1+0.12) / (1+0.16) ] ^6 ] x (1/1.16^2) = $1.058

- Second, calculate the Dividend receipt at the end of year 10 which is 0.3 x 1.12^6 x 0.94 = $0.557

- Calculate the present value of the dividend stream after Y9 which is a perpetuity:

[ 0.557 / (0.16 - (-0.06) ] x (1/1.16^9) = $0.666

- The stock price is equal to the sum of the present value of the two dividend streams calculated above = 1.058 + 0.666 = $1.724.