The Satellite Building Company has fallen on hard times.Its management expects to pay no dividends for the next 2 years.However, the dividend for Year 3, D3, will be R1.00 per share, and the dividend is expected to grow at a rate of 3 percent in Year 4, 6 percent in Year 5, and 10 percent in Year 6 and thereafter.If the required return for Satellite is 20 percent, what is the current equilibrium price of the shares?

Question

Quizplus · Accepted Answer

To calculate the current equilibrium price of the shares, we need to use the dividend discount model formula:

P0 = (D1 / (1+r)^1) + (D2 / (1+r)^2) + (D3 / (1+r)^3) + ((D3*(1+g3)) / (r-g3)*(1+r)^3)

Where:

P0 = current equilibrium price of the shares
D1 = expected dividend in Year 1 (zero in this case)
D2 = expected dividend in Year 2 (zero in this case)
D3 = expected dividend in Year 3 (R1.00 per share)
r = required return (20%)
g3 = growth rate of dividend in Year 3 (3%)
g4 = growth rate of dividend in Year 4 (6%)
g5 = growth rate of dividend in Year 5 (10%)

Substituting the values in the formula, we get:

P0 = (0 / (1+0.20)^1) + (0 / (1+0.20)^2) + (1.00 / (1+0.20)^3) + ((1.00*(1+0.03)) / (0.20-0.03)*(1+0.20)^3) + ((1.00*(1+0.06)) / (0.20-0.06)*(1+0.20)^4) + ((1.00*(1+0.10)) / (0.20-0.10)*(1+0.20)^5)

Solving for P0, we get:

P0 = R6.34

Therefore, the best choice is C) R6.34.

The Satellite Building Company Has Fallen on Hard Times