Question
9.3 AAA Company is expanding rapidly and currently needs to retain all of its earnings; hence it does not pay dividends in Year 1. However,
9.3 AAA Company is expanding rapidly and currently needs to retain all of its earnings; hence it does not pay dividends in Year 1. However, investors expect AAA to begin paying dividends, beginning with a dividend of $0.50 in Year 2. The dividend should grow rapidly at a rate of 30% per year-during Years 3 and 4, growth should be a constant 5% per year. If the required return on AAA is 10% what is the value of the stock today? (Draw a timeline to visualize the problem and show detailed steps of your analysis) 0-------------1-------------2------------------3----g=30%----------4------g=30%-------5-g=5% rs=10% D2=$0.50 D3=1.10 D4=0.85 D5=0.89 =0.50(1+0.30)=1.10 =0.50(1+0.30)=0.85 =0.85(+0.05)=0.89 4=D5/rs-g 4=0.89/(0.10-0.05)=$17.80 1=D2 =0.50 2=D3/(1+rs) =1.10/(1+0.10) =0.826 3=D4/(1+rs) =0.85/(1+0.10) =0.702 4=D5/(1+rs) =17.80/(1+0.10) =14.71 0=PV(D1)+PV(D2)+PV(D3)+PV(D4)+PV(4) 0=0+0.50+0.826+0.702+14.71 0=$16.74
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