Question

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next ten years, because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $13.50 per share 11 years from today and will increase the dividend by 5.25 percent per year thereafter. The required return on the stock is 13.25 percent.1. What is the price of the stock 10 years from today?2. What is the current share price?

Answer 1

Answer:

1. The price of the stock 10 years from today is $150 per share.

2. The current share price is $43.22 per share.

Explanation:

1. What is the price of the stock 10 years from today?

To calculate this, the dividend growth model formula is used as follows:

P = D1 / (r - g) ............................ (1)

Where,

P = Stock price 10 years from today = ?

D1 = Dividend 11 years from today = $13.50

r = required return = 13.25%. or 0.1325

g = dividend growth rate = 5.25%, or 0.0525

Substituting the values into equation (1), we have:

P = $13.50 / (0.1325 - 0.0425)

P = $150

Therefore, the price of the stock 10 years from today is $150 per share.

2. What is the current share price?

This can be calculated using the present value formula as follows:

Current share price = P / (1 + r)^Number of years = $150 / (1 + 0.1325)^10 = $43.22

Therefore, the current share price is $43.22 per share.