Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next seven years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $14.25 per share 8 years from today and will increase the dividend by 6.00 percent per year thereafter. Required: If the required return on this stock is 14.00 percent, what is the current share price?

Question

Laurel

Business

5 November, 09:38

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next seven years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $14.25 per share 8 years from today and will increase the dividend by 6.00 percent per year thereafter. Required: If the required return on this stock is 14.00 percent, what is the current share price?

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Answers (1)

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Judith · Answer 1

The price of the stock today will be $66.19

Explanation:

To calculate the price of a stock whose dividends will grow at a constant rate forever is calculated using the constant growth model of dividend discount model approach. To calculate the price of the stock today using this model, we use the following formula,

P0 = D1 / r - g

We will first calculate the price of the stock at t=8 using D9 because we use the next period's dividend to calculate the price of a stock. We will then discount back the price at t=8 to today's price.

P8 = 14.25 * (1+0.06) / (0.14 - 0.06)

P8 = $188.8125

The price of the stock today will be,

P0 = 188.8125 / (1+0.14) ^8

P0 = $66.189 rounded off to $66.19