Question

The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D1) at the end of the current year will be $1.30. The growth rate (g) is 9 percent and the discount rate (Ke) is 14 percent. a. What should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.) Price of the stock b. If there is a 7 percent total underwriting spread on the stock, how much will the issuing corporation receive? (Do not round intermediate calculations and round your answer to 2 decimal places.) Net price to the corporation c. If the issuing corporation requires a net price of $24.50 (proceeds to the corporation) and there is a 7 percent underwriting spread, what should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.) Necessary public price

Answer 1

Three variables are included in the calclation of value of stock, Gordon Growth Model formula:

i) D1 or the expected annual dividend per share for the following year

ii) ke or the required rate of return

iii) g or the expected dividend growth rate.

With these variables, the value of the stock can be computed as:

Intrinsic Value = D1/ (ke – g)

Answer for (a) : $28.34

EXPECTED PRICE OF THE COMPANY'S STOCK
Particulars	Amount	Remarks
Dividend (D0)	$                      1.30	A (given)
Growth rate (g)	9.00%	B (given)
Required return (Ke)	14.00%	C (given)
Dividend (D1)	$                      1.42	D = A * (1+B)
Difference between Ke and g	5.00%	E = C - B
expected value of company's stock	$                    28.34	F = D ÷ E

Answer for (b) : $26.36

NET PRICE OF CORPORATION
Particulars	Amount	Remarks
Price of stock	$                    28.34	A (calculated above)
Underwriting spread @ 7%	$                      1.98	B = A x 7%
Net price of corporation	$                    26.36	C = A - B

Answer for (c) : $26.34

EXPECTED PRICE OF THE COMPANY'S STOCK For NET PRICE BEING $24.5
Particulars	Amount	Remarks
Net price of corporation	$                    24.50	A (GIVEN)
Underwriting spread @ 7%	$                      1.84	B = A x 7/93
Price of stock	$                    26.34	C = A + B