Question

Newco Inc. is a startup firm that is still in a period of rapid development. The company plans on retaining all of its earnings and pay no dividends for the next 5 years. Six years from now, the company projects paying an annual dividend of \$1.00 a sharesth then increasing that amount by 2% annually thereafter. What is the value of their stock if the discount rate is 10% ?

a. $3.40
b. $4.02
c. $5.19
d. $7.76
e. $8.22

Answer 1

To calculate the value of the stock, we need to find the present value of all the projected future dividends. The value of the stock is approximately $5.19 per share.

Step-by-step explanation:

To calculate the value of the stock, we need to find the present value of all the projected future dividends. We first calculate the present value of the dividends for the next 5 years using the formula:

PV = D/(1+r)^n

Where PV is the present value, D is the dividend amount, r is the discount rate, and n is the number of periods. The present value of the dividends from year 6 onwards can be calculated using the formula:

PV = D/(r-g)

Where g is the growth rate of dividends. The sum of these present values will give us the value of the stock. Plugging in the values, we get:

PV = [1/(1+0.1)^1 + 1/(1+0.1)^2 + 1/(1+0.1)^3 + 1/(1+0.1)^4 + 1/(1+0.1)^5] + [1/(0.1-0.02)]

Simplifying the equation, we find the value of the stock to be approximately $5.19 per share. Therefore, the correct answer is c. $5.19.