Eastern Auto Parts' last dividend was Do = $0.50,and the company expects to experience no growth in the next 2 years.However eastern will grow at an annual rate of 5% in the third and fourth years,and,beginning with the fifth year,it should attain a 10% growth rate which it should sustain thereafter.Eastern has a cost of capital of 12%.What should be the present price per share of Eastern common stock?

Question

Quizplus · Accepted Answer

Step 1 - Calculate the present value over the zero-growth cash flow years.
PV = 11ea7fdb_fbf6_9cfd_a768_e184d543eb40_TB2902_11 = $.45
PV = 11ea7fdb_fbf6_9cfe_a768_c787e871704e_TB2902_11 = $.40
Step 2 - Calculate the present value of the 5% growth years.
PV = 11ea7fdb_fbf6_9cff_a768_05f82b931339_TB2902_11 = $.37
PV = 11ea7fdb_fbf6_9d00_a768_ad3288af3c08_TB2902_11 = $.35
Step 3 - Calculate the price of the stock for the constant-growth years and discount it back to today. 11ea7fdb_fbf6_9d01_a768_af6d6b8de199_TB2902_11 = 11ea7fdb_fbf6_c412_a768_87c72f8e7c15_TB2902_11 11ea7fdb_fbf6_c413_a768_a7a62e2d2dc5_TB2902_11 = 11ea7fdb_fbf6_c414_a768_d3b7bee0f808_TB2902_11 = $30.32
PV = 11ea7fdb_fbf6_c415_a768_394fad742901_TB2902_11 = $19.27
Step 4 - Add all of the present values together to get the stock price today.
.45 + .40 + .37 + .35 + 19.27 = $20.84

Eastern Auto Parts' Last Dividend Was Do = $0