Question

Sultan Services has 1.4 million shares outstanding. It expects earnings at the end of the year of $ 5.20 million. Sultan pays out​ 60% of its earnings in total​ - 40% paid out as dividends and​ 20% used to repurchase shares. If​ Sultan's earnings are expected to grow by 55​% per​ year, these payout rates do not​ change, and​ Sultan's equity cost of capital is 10%, what is​ Sultan's share​ price?

Answer 1

Answer: $49.52

Step-by-step explanation:

To solve this we can use the Gordon Growth Model of Stock Valuation because the growth rate is constant.

The formula goes like this,

Value of stock = D1 / r – g.

D1 = the annual expected dividend of the next year.

r = rate of return or cost of capital .

g = the expected dividend growth rate (assumed to be constant)

First we'll calculate the next dividend/pay out which is 60% of earnings.

= 5.2 million * (0.6)

= $3.12 million.

Putting the figures into the formula would give us (we will assume the growth rate of 55% written there is a typo because such a growth rate vs that Equity cost of capital is implausible and instead use a growth rate of 5.5% ),

Value of stock = D1 / r – g.

= 3.12 / (0.1 - 0.055)

= $69.33 million

To find the share drive we will then divide the total value of stock by the number of shares outstanding.

= 69.33/1.4

= $49.52

Sultan's Share Price is therefore $49.52