Category: Business and Money > Finance
Asked by: ozzie1905-ga
List Price: $6.00
12 Sep 2006 07:38 PDT
Expires: 12 Oct 2006 07:38 PDT
Question ID: 764467
The stock of Robotic Atlanta Inc. is trading at $40 per share. In the past, the firm has paid a constant dividend of $5 per share and it has just paid an annual dividend. However, the company will announce today new investments that the market does not know about. It is expected that with these new investments, the dividends will grow at 5% forever. Assuming that the discount rate remains the same, what will be the price of the stock after the announcement?
Answered By: livioflores-ga on 15 Sep 2006 07:02 PDT
Hi!! To solve this you must use the Constant Growth Stock Valuation formula. Let me define the variables: Pi = price at year i P0 = today's price Di = dividends in period i r = rate of return on the stock g = constant growth rate Since stock initially pays constant dividends (0-growth), then r = D0/P0 = 5/40 = 0.125 (12.5%) After the announcement the stock will become from a 0%-growth to a 4%-growth, and the new price, according to the Constant Growth Stock Valuation formula, will be: New P0 = D1/(r-g) = = D0*(1+g)/(r-g) = = 5*(1.04)/(0.085) = = 61.18 The new price will be $61.18 . For a references about the formula see: "Constant Growth Stock Valuation": http://www.globusz.com/ebooks/Valuation/00000020.htm Regards, livioflores-ga
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