Question
Whizz Corp. has recently paid a dividend of $3 per share. You expect that the dividend will be $3 next year (t=1), increase 20% the
Whizz Corp. has recently paid a dividend of $3 per share. You expect that the dividend will be $3 next year (t=1), increase 20% the following year (t=2), then increase 10% the following year (t=3), and then grow at a rate of 5% indefinitely (after t=3). The company's assets are worth $150 million, and its debt is worth $75 million. Its asset beta is 2. You estimate that the risk-free rate is 5%, and the market risk premium is 5% as well. The company's tax rate is 0%. If your estimations are correct, what is the value of the stock today?
Solution Step 1: Calculating the required rate of return on equity First, we need to calculate the beta BE = [(1 + (75 / 75)] * 2 = 4 RE = 5 + (5 * 4) = 25% Step 2: Calculating the value of the stock PV D1 = 3/1.25 = 2.4 PV D2 = 3.6/1.252 = 2.304 PV D3 = 3.96/1.253 = 2.028 D4 = 3.96 * 1.05 = 4.158 P3 = 20.79 PV of P3 = 20.79/1.253 = 10.64 Value of the stock = 2.4 + 2.304 + 2.208 + 10.64 = $17.55 The Part that I am confused at is where the professor attained P3's value.
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