Question
The Nice Hair Drug Company (NHDC) just reported earnings of $2 million. The company was founded 10 years ago to market a new hair ointment,
The Nice Hair Drug Company (NHDC) just reported earnings of $2 million. The company was founded 10 years ago to market a new hair ointment, and is entirely equity-financed. To sustain its rapid growth, the company has so far been reinvesting all of its earnings, and has paid no dividends. The average annual rate of return on NHDC's investments has been 16%.
Analysts are expecting that the market for the ointment will stabilize in five years. At that point, while the profitability of NHDC will remain unchanged, the company will have to slow down its expansion, and start paying 60% of its annual earnings as dividends to the shareholders (i.e. the company starts paying 60% of its earnings in year 5).
Assume the riskless interest rate is 7%, that the expected rate of return on the market portfolio in excess of the riskfree rate is 5.5%, and that NHDC's equity beta is 1.2.What is the current value of NHDC's equity?
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