Darcy Inc. has just paid out a dividend (annual) of$2.40 per share. Th

QUESTION

Darcy Inc. has just paid out a dividend (annual) of$2.40 per share. The company is in a state of rapid growth of12%, which can only be sustained for the next 4 years. Afterthat, its earnings growth is expected to drop to a long-termsustainable growth of 4%. Its dividends will grow at
Dividend just paid (D 0 ) = $2.40 per share The Company is in a state of rapid growth of 12% which can onlybe sustained for the next 4 years Expected dividend growth rate = 4% per year Calculating Expected dividend in each of the Next 4Years: Dividend in First year (D 1 ) = $2.40 (1 0.12) = $2.688 Dividend in Second year(D 2 ) = $2.688 (1 0.12) = $3.01056 Dividend in Third year (D 3 ) = $3.01056(1 0.12) = $3.3718 Dividend in fourth year (D 4 ) = $3.3718(1 0.12) = $3.7764 After 4 years the earnings growth is expected to drop to along-term sustainable growth of 4% Dividend in fifth year (D 5 ) = $3.7764 (1 0.04) = $3.9275 Dividend in sixth year (D 6 ) = $3.9275 (1 0.04) = $4.0846 Calculating Required Return (R E ) using SMLapproach: Risk-free rate(R f ) = 3.5% Stockbeta = 1.45 Expected return on Market(R M ) = 14% Required return (R E ) = R f (R M R f )

equired return (R E ) = 0.035 1.45 (0.14 0.035) = 0.035 1.45(0.105) = 0.035 0.15225 = 0.1872 (or) 18.72% Required return(R E ) = 18.72% Stock Price (P 5 ) = D 6 / (0.1872 0.04) = $4.0846 / 0.1472 = $27.75 Stock Price(P 5 ) = $27.75 Calculating Todays StockValue: P 0 = [D 1 /(1 R) D 2 /(1 R) 2 D 3 /(1 R) 3 D 4 /(1 R) 4 D 5 /(1 R) 5 P 5 /(1 R) 5 ] = [$2.688/(1.1872) $3.01056/(1.1872) 2 $3.3718/(1.1872) 3 $3.7764/(1.1872) 4 = $3.9275 / (1.1872) 5 $27.75 / (1.1872) 5 = $2.26 $2.13599 $2.015 $1.90 $1.66 $11.766 = $21.74 Todays Stock Value(P 0 ) = $21.74 Hope it may help you

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