McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

Question

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$\begin{array}{lr}
\text { Last dividend }\left(\mathrm{D}_{0}\right) & \$ 1.25 \
\text { Short-run growth rate } & 25 \% \
\text { Long-run growth rate } & 0 \% \
\text { Beta } & 1.20 \
\text { Market risk premium } & 5.50 \% \
\text { Risk-free rate } & 3.00 \% \
\text { Required return }=r_{\mathrm{S}}=\mathrm{r}_{\mathrm{RF}}+\mathrm{b}\left(\mathrm{R} \mathrm{P}_{\mathrm{M}}=\right. & 9.60 \%
\end{array}$ 
 $\begin{array}{lcccccc}
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \
\hline & & 25 \% & 25 \% & 25 \% & 25 \% & 0 \% \
\text { Dividend } & \$ 1.2500 & \$ 1.5625 & \$ 1.9531 & \$ 2.4414 & \$ 3.0518 & \$ 3.0518 \
\text { Horizon value }=\mathrm{D}_{5} /\left(\mathrm{r}_{\mathrm{S}}-\mathrm{g}_{5}\right)= & & & 31.7891 & & & \
\hline \text { Total CFs } & & \$ 1.5625 & \$ 1.9531 & \$ 2.4414 & \$ 34.8409 & \
\mathrm{PV} \text { of the CFs } & & \$ 1.4256 & \$ 1.6260 & \$ 1.8544 & \$ 24.1461 &
\end{array}$ 
Price = Sum of PVs = $29.05

McGaha Enterprises Expects Earnings and Dividends to Grow at a Rate