

Subject:
Finance
Category: Reference, Education and News > Homework Help Asked by: jaemariega List Price: $5.00 
Posted:
19 Sep 2005 15:23 PDT
Expires: 19 Oct 2005 15:23 PDT Question ID: 569844 
Company Zprime is like Z in all respects save one : Its growth will stop after 4 year. In year 5 and afterward, it will pay ot all earnings as dividends. What is Zprime's stock price? Assume next year's EPS is $15.  
 


Subject:
Re: Finance
Answered By: omnivorousga on 19 Sep 2005 21:53 PDT Rated: 
Jaemarie ? Here are the important assumptions about ZPrime: ? Year 1 dividend = $10 ? Year 2 dividend = $10.50 ? Year 3 dividend = $11.025 ? Year 4 dividend = $11.576 ? Year 5 and onwards: $17.36 Ks or discount rate = 8% This provides the following discount factors for NPV: Year1: 1/1.08 = .9259 Year2: 1/(1.08)^2 = .8573 Year3: 1/(1.08)^3 = .7938 Year4 1/(1.08)^4 = .7350 Year5: 1/(1.08)^5 = .6806 So it become easy to track NPV of the cash flows for years 14 by multiplying each by their NPV factor: Year1: $9.26 Year2: $9.00 Year3: $8.75 Year4: $8.51 But what?s the value of the neverending series of dividend payments from year 5 to eternity? CONSTANT GROWTH MODEL ========================== Also called the Dividend Valuation Model, this allows an investor to calculate a value based on returns to the investor. Here, the dividends represent cash flows ? something that?s not always true in the real world. The general model for stock pricing is below. We?ll use period 5 (year 5) but you can use i as year one or any other starting point if you?re an analyst trying to figure out how to value a company  Pi = Di / (Ks  g) Pi = price in period i Di = dividends in period i Ks = required rate of return (in decimals) g = dividend growth rate (in decimals) i = period, usually expressed in years So the value at the end of year 5 is: P = $17.36 / (0.08 ? 0.05) = $17.36 / 0.03 = $578.67 However, that?s the value in year 5 ? not today. We have to discount it back to year 0 (that?s how ?today? is often described in financial problems ? so it?s: $578.67 * Year5 NPV factor = $393.84 TOTAL VALUE OF ZPRIME = $9.26 + $9.00 + $8.75 + $8.51 + $393.84 = $429.36 Google search strategy: ?constant growth model? dividends Best regards, OmnivorousGA  

jaemariega rated this answer: 

Subject:
Re: Finance
From: marcomplyga on 23 Sep 2005 12:19 PDT 
As I was looking at the answers, how did you calculated ZPrime's 5 year onward dividend to be at $17.36? 
Subject:
Re: Finance
From: libertybellga on 09 Oct 2005 18:29 PDT 
I also could not figure out the $17.36 
Subject:
Re: Finance
From: hakbergga on 29 Nov 2005 13:51 PST 
How could you use the EPS of $15 to find this answer? Or is there somehow a simpler way to calculate the NPV of yrs 14 as a growth stock and then add that to the NPV of Yr 5 as a dividend/nongrowth stock for the price? 
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