Question

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Stock Valuation: HighTech Company is expected to retain all of its earnings for the next two years but start to pay dividends 3 years from today. The first dividend is expected to be $3. Assume that the dividends will grow rapidly at a rate of 10% per year during years 4 to 7. For each year after that it grows at a constant rate of 5%. Assume a discount rate of 12%. a) b) What is HighTech's stock price? Assume that instead of growing at a 5% constant rate starting from year 8, HighTech Company expects, in year 8, to earn an EPS of $8 and reinvest $4 per share to develop new technology. The new technology will generate a 15% return permanently. What is the constant growth starting from year 8? What is the stock price today given this constant growth rate?

Answer 1

Year		Dividend	PV factor	Present Values
1		-	0.892857	-
2		-	0.797194	-
3		3.00	0.71178	2.14
4	3*110%	3.30	0.635518	2.10
5	3.3*110%	3.63	0.567427	2.06
6	3.63*110%	3.99	0.506631	2.02
7	3.99*110%	4.39	0.452349	1.99
7		65.88	0.452349	29.80
			Total PV	40.10
Current cash flow	4
Rate of return	12.00%
Growth Rate	5.00%
Horizon value at T7	=Current cash flow *(1+Growth rate)/(Rate of return-Growth Rate)
	'4.3923*(1+0.05)/(0.12-0.05)
	65.88
Stock price today is 40.10

Year		Dividend	PV factor	Present Values
1		-	0.892857	-
2		-	0.797194	-
3		3.00	0.71178	2.14
4	3*110%	3.30	0.635518	2.10
5	3.3*110%	3.63	0.567427	2.06
6	3.63*110%	3.99	0.506631	2.02
7	3.99*110%	4.39	0.452349	1.99
7		104.93	0.452349	47.46
			Total PV	57.77
Current cash flow	4
Rate of return	12.00%
Growth Rate	7.50%
Horizon value at T7	=Current cash flow *(1+Growth rate)/(Rate of return-Growth Rate)
	'4.3923*(1+0.075)/(0.12-0.075)
	104.93
Stock price today is 40.10
Growth rate calculation
EPS	8
Dividend	4
Retention rate	(8-4)/8
Retention rate	50%
Growth rate=	Retention rate * Return on investment
Growth rate=	50%*15%
Growth rate=	7.500%