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Philadelphia SteelWorks, Inc. has had steady earnings for the last several years and foresees this happening...

Philadelphia SteelWorks, Inc. has had steady earnings for the last several years and foresees this happening in the near future. However, a new technology that is in the works allows PSW to forecast growth in the next few years. Specifically, the dividends PSW expects to pay in the next three years is $3 per share. Starting in year 4, the company expects to increase this dividend 6% per year indefinitely. What is the stock price of PSW if investors during this time period require a 10% return on their investment?

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Answer #1

The price is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)1 + Dividend in year 2 / (1 + required rate of return)2 + Dividend in year 3 / (1 + required rate of return)3 + 1 / (1 + required rate of return)3 [ ( Dividend in year 3 (1 + growth rate) / (required rate of return - growth rate) ]

= $ 3 / 1.10 + $ 3 / 1.102 + $ 3 / 1.103 + 1 / 1.103 [ ( $ 3 x 1.06 ) / (0.10 - 0.06) ]

= $ 3 / 1.10 + $ 3 / 1.102 + $ 3 / 1.103 + $ 79.50 / 1.103

= $ 67.19 Approximately

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