Question

Use the information to answer the following questions. ABC Company has been growing at a 10% rate, and it just paid a dividend of $3.00. Due to a new product, ABC expects to achieve a dramatic increase in its short-run growth rate, to 20% annually for the next 2 years. After this time, growth is expected to return to the long-run constant rate of 10%. The company's beta is 2.0, the required return on the market is 11%, and the T-bill rate is 7%. What should be the stock price today?? Select one: a. $95.04 b. $77.26 c. $78.26 d. $99.36 e. $81.26 Continued from previous question. You expect the stock price to during the first year. Select one: a. Increase by 4.60% ОО b. Decrease by 10.00% c. Increase by 10.40% Ο Ο Ο d. Decrease by 4.60% e. Decrease by 10.40%

Answer 1

Solution:-

To Calculate Required Rate of Return-

As per Capital Assets Pricing Model,

Required Rate of Return = Risk Free Rate + Beta * (Market Return - Risk Free Rate)

Required Rate of Return = 0.07 + 2 * (0.11 - 0.07)

Required Rate of Return = 15%

To Calculate Terminal Value at the year end 2-

Terminal Value =

DPS2 * (1 +G) Required Rate - Growth Rate

Terminal Value =

4.32 *(1+0.10) 0.15-0.10

Terminal Value = $95.04

To Calculate Stock Price -

A B D E C Value of Stock 1 Year 1 2 3 4 5 6 7 8 Dividend Required Rate @15% 3.60 0.870 99.36 0.756 Present Value 3 75.13 2 Value of Stock 78.26

A B D E 1 Value of Stock (Formula Sheet) 2 3 Year 4 1 52 Dividend =3*1.2 =B4*1.2+95.04 Required Rate @ 15% = 100/115 =C4*100/115 Present Value =B4*C4 =B5*C5 Value of Stock 7 8 =SUM(D4:05)

Stock Price is $78.26

The Correct Answer is point C i.e. $78.26

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