Question

Big Red Machines, a startup, has come up with a new product and has seen significant customer demand. Due to reinvestment in the firm (100% plowback ratio) Big Red Machines will pay no dividends in the first 2 years. Beginning in the 3rd through 6th years, the firm expects to pay $1.50, $1.60, and $1.75 In the 6th year, the firm should see stable growth rates and thus begin a divided which grows at 3% per year. You plan to graduate 1 year from now, and hope to invest in Big Red Machines at that time. The expected rate of return is 8% What is the value of Big Red Machine's stock one year from today

Answer 1

The correct answer is "$ 30.34".

Step-by-step explanation:

The value of the stock can be computed by the following formula:

⇒
`(Dividend \ in \ year \ 3)/((1 + Required \ return \ rate)2) + (Dividend \ in \ year \ 4)/((1 + Required \ return \ rate)3) + (Dividend \ in \ year \ 5)/((1 + Required \ return \ rate) 4 ) + (1)/((1 + Required \ return \ rate)4 )* [\frac{( Dividend \ in \ year \ 5 (1 + Growth \ rate)} {( Required \ return \ rate - Growth \ rate)}]`

On putting the values, we get

⇒
`(1.50)/(1.08^2) + (1.60)/(1.08^3) + (1.75)/(1.08^4 ) + (1)/(1.08^4) * [ (( 1.75* 1.03))/((0.08 - 0.03))]`

⇒
`(1.50)/(1.08^2 ) + (1.60)/( 1.08^3 ) + (37.80)/( 1.08^4 )`

⇒
`30.34` ($)