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Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine yea...

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $14 per share 10 years from today and will increase the dividend by 6 percent per year thereafter. If the required return on this stock is 12 percent, what is the current share price?
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Answer #1

We have following formula to calculate total return on stock with constant dividend growth

P0 = D1 / (re –g)

And above formula can be modified in following manner

P9 = D10 / (re –g)

Where

Price of stock after 9 years P9 =?

Expected Dividend after 10 years D10 = $14 per share

Constant Dividend growth rate g = 6% per year

Discount rate or required rate of return re =12% per year

Therefore

P9 = $14/ (12% - 6%)

P9 = $233.33

Expected price of stock after 9 years is $233.33 and discount rate is 12% per year

Therefore,

Current value of stock P0 = P9 / (1+12%) ^9

= $233.33/ (1.12) ^9

= $84.14

Current value of this stock is $84.14 per share

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