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    Supernormal growth model and common stocks

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    (Supernormal growth model) Gebhardt Corp. has recently undertaken a major expansion project that is expected to provide growth in earnings per share of 400% within the coming year and 75% growth in each of the subsequent three years. After that time, normal growth of 3% per year forever is expected. The cash dividend was 10 cents per share this last year and is expected to be that amount for each of the next five years. In the sixth year, it is expected that the payout ratio will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. If the required return on Gebhardt common stock is 32% per year and the latest earnings per share were 25 cents, at what price should Gebhardt Corp. common stock be selling in the market?

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    Solution Preview

    The price would be the present value of dividends. Based on the details provided, we should calculate the expected dividends from the stock.

    We are given that D0 (current dividend) = 0.10
    and D1 to D5 would also be 0.10
    From year 6, D6 = 80% of EPS and then would ...

    Solution Summary

    The following posting discusses common stock and markets.