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Experience: MBA in Finance and Marketing

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Quiz Question 8
8. Company Z-prime is like Z in all respects save one: Its growth will stop after year 4. In
year 5 and afterward, it will pay out all earnings as dividends. What is Z-primeâ€™s stock
price? Assume next yearâ€™s EPS is $15.

Reply to XXXXX XXXXX's Post: this is all that was given in the text.

7. Company Z’s earnings and dividends per share are expected to grow indefinitely by 5
percent a year. If next year’s dividend is $10 and the market capitalization rate is 8 percent,
what is the current stock price?

8. Company Z-prime is like Z in all respects save one: Its growth will stop after year 4. In
year 5 and afterward, it will pay out all earnings as dividends. What is Z-prime’s stock
price? Assume next year’s EPS is $15.

Customer:replied 11 years ago.

7. Company Z's earnings and dividends per share are expected to grow indefinitely by 5
percent a year. If next year's dividend is $10 and the market capitalization rate is 8 percent,
what is the current stock price?

8. Company Z-prime is like Z in all respects save one: Its growth will stop after year 4. In
year 5 and afterward, it will pay out all earnings as dividends. What is Z-prime's stock
price? Assume next year's EPS is $15.

Customer:replied 11 years ago.

More info for question 8. Hope this helps

7. Company Z’s earnings and dividends per share are expected to grow indefinitely by 5
percent a year. If next year’s dividend is $10 and the market capitalization rate is 8 percent,
what is the current stock price?

8. Company Z-prime is like Z in all respects save one: Its growth will stop after year 4. In
year 5 and afterward, it will pay out all earnings as dividends. What is Z-prime’s stock
price? Assume next year’s EPS is $15.

9. If company Z (see question 7) were to distribute all its earnings, it could maintain a level
dividend stream of $15 a share. How much is the market actually paying per share for
growth opportunities?

7. Value = DPS1 (dividends next year)/(rate - growth), or 10/(.08-.05) = 333.33.

8. For this you need a two-stage dividend growth model. The formula is complicated, but I'll try to write it here:

Value = DPS1t/(1+r)t + EPS*(1+g)*new payout ratio/r-g. Bascially saying that the value is equal to the dividends in the growth phase (years 1 to 4) plus the present value of dividends in the non growth phase (after year 4).

So for the growth phase, dividend grow at 5% for 4 years. The PV of that equals 10/1.08 + 10(1.05)/1.08^2 + 10(1.05)^2/(1.08)^3 + 10(1.05)^3/(1.08)^4 = 35.52.

Then for the non growth phase = $15 * 1+g * 100%/(.08-0), since g = 0 and payout is 100% (all earnings)= 187.5.

Add that to 35.52, and you get 223.02.

9. If it paid out 15, then the stock price would be 15/.08 or 187. Thus the market is paying 333 less 187.5 or 145.5 per share for growth.

I only wish to add to the answer for Question 8. For the non growth phase, we should use the EPS as of year 4. In Question 7 it says that EPS also grows by 5% a year. The EPS value to be used should be 15*(1.05)^4