Question

a) Roxborough Inc. just paid a dividend of $7.35 per share. The company will increase its dividend by 25 percent every year for next two years and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 10 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 12 percent, what will a share of stock sell for today? b) Assuming the following ratios are constant, what is the sustainable growth rate? Total Assets turnover Profit margin Equity Multiplier Payout ratio 2.7 6.50 % 1.2 35%

Answer 1

Part A

Year	Dividend rate	Dividends
1	25%	$            9.18750000	7.35*(1+25%)
2	25%	$          11.48437500	9.1875*(1+25%)
3	20%	$          13.78125000	11.4843750*(1+20%)
4	15%	$          15.84843750	13.78125*(1+15%)
5	10%	$          17.43328125	15.8484375*(1+10%)

Dividend for fifth year	$        17.433281250
Dividend by: Required rate less growth rate (12%-5%)	7%
Year 4 terminal value	$                      249.05

Year	PV factor @ 12%	Remarks
1	0.89286	= 1 / 1.12
2	0.79719	= 0.89286 / 1.12
3	0.73814	= 0.79719 / 1.12
4	0.68347	= 0.73814 / 1.12

Year	Dividend	PV factor @12%	Present value
1	$                 9.19	0.89286	$                          8.20
2	$               11.48	0.79719	$                          9.16
3	$               13.78	0.71178	$                          9.81
4	$               15.85	0.63552	$                       10.07
Year 4 terminal value	$             249.05	0.63552	$                     158.28
	Price of the share		$                     195.52

Part B

Payout ratio	35%
Retention ratio (1-35%)	65%
Profit margin	6.50%
Multiply: Retention ratio	65%
Growth rate	4.2250%
Growth rate (Rounded)	4.23%