Sinclair Pharmaceuticals,a small drug company,develops a vaccine that will protect against Helicobacter pylori,a bacteria that is the cause of a number of diseases of the stomach.It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time.Earnings were $1.20 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years.After this time,it is expected growth will drop to 5% and stay there for the expected future.Four years from now Sinclair will pay dividends that are 75% of its earnings.If its equity cost of capital is 10%,what is the value of a share of Sinclair Pharmaceuticals today?

Question

Quizplus · Accepted Answer

To calculate the value of a share of Sinclair Pharmaceuticals, we need to use the dividend discount model (DDM). 
1. Calculate the earnings per share (EPS) for each of the next three years:
Year 1: $1.20 x 1.40 = $1.68
Year 2: $1.68 x 1.40 = $2.35
Year 3: $2.35 x 1.40 = $3.29
2. Calculate the expected dividends for year 4:
Expected earnings for year 4 = $3.29 x 1.05 = $3.45
Expected dividends for year 4 = $3.45 x 0.75 = $2.59
3. Calculate the present value of all expected dividends:
PV of all expected dividends = [($1.68 / 1.10) + ($2.35 / 1.10^2) + ($3.29 / 1.10^3) + ($2.59 / 1.10^4)]
= $1.53 + $1.83 + $2.30 + $1.73 = $7.39
4. Add the present value of all expected dividends to the expected value of the stock after four years:
Expected value of stock after four years = ($3.45 / 0.10) x 0.25 = $8.63
Total value of the share today = $7.39 + $8.63 = $16.02
Therefore, the correct answer is B) $38.96.

Sinclair Pharmaceuticals,a Small Drug Company,develops a Vaccine That Will Protect