9-21 NONCONSTANT GROWTH

Assume that it is now January 1, 2019. Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the next 5 years. Other firms will have developed comparable technology by the end of 5 years, and WMEs growth rate will slow to 5% per year indefinitely.

Stockholders require a return of 12% on WMEs stock. The most recent annual dividend (D0), which was paid yesterday, was $1.75 per share.

Q1: How might an investors tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does WMEs stock become mature for purposes of this question?

Q2: Suppose your boss tells you she believes that WMEs annual growth rate will be only 12% during the next 5 years and that the firms long-run growth rate will be only 4%. Without doing any calculations, what general effect would these growth rate changes have on the price of WMEs stock?

Q3: Suppose your boss also tells you that she regards WME as being quite risky and that she believes the required rate of return should be 14%, not 12%. Without doing any calculations, determine how the higher required rate of return would affect the price of the stock, the capital gains yield, and the dividend yield. Again, assume that the long-run growth rate is 4%.