Question

McGaha Enterprises expects earnings and dividends to grow at a rate of 28% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

Answer 1

Answer:

The current price of the common stock is $29.05

Explanation:

Cost of Equity = Rf + beta x MRP = 3% + 1.20 × 5.50% = 9.6%

Dividend in the n the year = D₀ × $(1+g)^n$

D₁ = $1.25 × 1.25 = $1.56255

D₂ = $1.5625 × 1.25  = $1.9531

D₃ = $1.9531 × 1.25   = $2.44

D₄ = $2.44 × 1.25 = $3.052

Terminal value = D₄ × $(1+g5)/r5-g5$

= $3.052 x (1+0.0) ÷ (9.60 - 0.0)

= $31.79

Total value in 4th year = $3.052 + $31.79 = $34.8409

Total cash flows = $1.5625, $1.9531, $2.4414,  $34.8409

(Present value Cash-flows at 9.60% ) $1.4256, $1.6260, $1.8544, $24.1461

= $29.05

Current price = $29.05