EBK CONTEMPORARY FINANCIAL MANAGEMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN: 9781337514835
Author: MOYER
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 7, Problem 22P
Summary Introduction

To determine: Current value of stock.

Given information:

Earning growth rate for starting three years will be = 50%

Earning growth rate for following three years will be = 25%

After that earning growth rate will be = 8%

Required equity return will be 20% (2-4 years), afterwards 50%

Calculation of current value of stock:

YearEarnings ($)Dividends ($)
01.000.00
11.500.00
22.250.45
33.3750.675
44.2190.844
55.2732.637
66.5923.296
77.1193.560

    Pm=Dm+1keg2

Here,

Pm is the stock value at the end of period,

Dm+1 refer to the dividend payment after non constant growth,

ke refer to expected rate of return,

g2 is expected growth after nonconstant growth.

    P6= $3.56/0.20  0.08 = $29.667

    P0=FVn(PVIFi,n)

Here,

FV refers to future value of investment,

i is interest rate,

n is number of periods,

PVIF refers to a used for calculation.

    P0= $0 + $0.45PVIF0.2,2 +$0.675PVIF0.2,3 + $0.844PVIF0.2,4 + $2.637PVIF0.2,5                  + $3.296 + $29.667 PVIF0.2,6 =$13.21

Hence, the price of stock will be $13.21

Expert Solution & Answer
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Explanation of Solution

Given information:

Earning growth rate for starting three years will be = 50%

Earning growth rate for following three years will be = 25%

After that earning growth rate will be = 8%

Required equity return will be 20% (2-4 years), afterwards 50%

Calculation of current value of stock:

YearEarnings ($)Dividends ($)
01.000.00
11.500.00
22.250.45
33.3750.675
44.2190.844
55.2732.637
66.5923.296
77.1193.560

    Pm=Dm+1keg2

Here,

Pm is the stock value at the end of period,

Dm+1 refer to the dividend payment after non constant growth,

ke refer to expected rate of return,

g2 is expected growth after nonconstant growth.

    P6= $3.56/0.20  0.08 = $29.667

    P0=FVn(PVIFi,n)

Here,

FV refers to future value of investment,

i is interest rate,

n is number of periods,

PVIF refers to a used for calculation.

    P0= $0 + $0.45PVIF0.2,2 +$0.675PVIF0.2,3 + $0.844PVIF0.2,4 + $2.637PVIF0.2,5                  + $3.296 + $29.667 PVIF0.2,6 =$13.21

Hence, the price of stock will be $13.21

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