Stock Values and Growth Opportunities
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1. Stock Values
The Brennan Co. just paid a dividend of $1.40 per share on its stock. The dividends are expected to grow at a constant rate of 6% per year indefinitely. If investors require a 12% return on the Brennan Co. stock, what is the current price? What will the price be in three years? In 15 years?
2. Growth Opportunities
California Real Estate, Inc. expects to earn $110 million per year in perpetuity if it does not undertake any new projects and returns all the earnings as dividends to the shareholders. The firm has an opportunity to invest $12 million today and $7 million in one year in real estate. The new investment will generate annual earnings of $10 million
in perpetuity, beginning two years from today. The firm has 20 million shares of common stock outstanding, and the required rate of return on the stock is 15%.
(a) What is the per-share stock price if the firm does not undertake the new investment?
(b) What is the per-share present value of the investment?
(c) What is the per-share stock price if the firm undertakes the investment?
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Solution Summary
This solution explains how to value a stock and how to value growth opportunities. Calculations and answers are provided.
Solution Preview
1. Use the constant growth formula to get the current price which is the present value of all dividends.
Current Price = D1/(ke-g)
D1 = expected dividend = D0 X (1+g) = 1.40 X (1+6%) = 1.484
Ke = required return = 12%
g = growth rate = 6%
Current Price = 1.484/(12%-6%) = $24.73
If we rearrange the above formula,we get
Ke = D1/MP + g
MP = Market Price or Current Price
The required return = D1/MP which is the dividend yield + g which is the capital gains yield
Therefore the market price will increase by the growth rate, since that is the capital gains, which is the change in price.
Price in 3 years ...
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