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    Company Z-prime is like Z in all respects save one: Its growth will stop after year 4. In year 5 and afterward, it will pay out all earnings as dividends. What is Z-prime's stock price? Assume next year's EPS is $15.

    Additional information:
    Company Z's earnings and dividends per share are expected to grow indefinitely by 5 percent a year. If next year's dividend is $10 and the market capitalization rate is 8 percent.

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    Solution Preview

    g= growth rate = plowback rate x return on capital (=r )

    g= 5%
    r= 8%
    Therefore plowback rate= 62.5% =5%/8%

    EPS= $15
    Therefore dividend= $5.625 =$15*(100%-62.5%)

    Div 1 = Dividend in year ...

    Solution Summary

    The solution calculates stock price given EPS, growth rate of dividends, market capitalization rate etc.

    $2.49

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