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max2010maxim [7]
2 years ago
7

The DAP Company has decided to make a major investment. The investment will require a substantial early cash out-flow, and inflo

ws will be relatively late. As a result, it is expected that the impact on the firm's earnings for the first 2 years will be a negative growth of 5% annually. Further, it is anticipated that the firm will then experience 2 years of zero growth after which it will begin a positive annual sustainable growth of 6%. If the firm's cost of capital is 10% and its current dividend (D0) is $2 per share, what should be the current price per share?
Business
1 answer:
Ivanshal [37]2 years ago
8 0

Answer:

$8.29$, is the right answer.

Explanation:

Let's assume that, there are three stages of growth therefore three stage dividend discount formula is being used.

Dividend (D1) = 2

The negative growth is of 5%

D1=2(1-0.05)=1.90

The present value of D1 =2

P(D1)=\frac{1.90}{1+0.1}=1.72

D2=1.95*0.95=1.85

P(D2)= \frac{1.85}{(1+.1)^{2}}

P(D2)=1.52

SECOND PERIOD OF ZERO GROWTH FOR TWO YEARS

D3=1.85 \\P(D3)= \frac{1.85}{(1+.1)^{3}}

P(D3)=1.38\\P(D4)=1.26

THREE PERIOD IS CONSTANT GROWTH 6%

D5=1.85(1+.06)=1.961 \\P(D5)= \frac{1.961}{(1+.1)^5} \\P(D5)=1.21 \\D6=1.961 \times  1.06==2.07 \\P(D6)=\frac{2.07}{(1.1)^6} \\P(D6)=1.17

The equity values are = P(D1)+P(D2)+P(D3)+P(D4)+P(D5)+P(D6)

Equity values = 1.72+1.52+1.38+1.26+1.21+1.17=8.29

Therefore, the current price will be $8.29$

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