NYC Company has decided to make a major investment.The investment will require a substantial early cash outflow,and inflows will be relatively late.As a result,it is expected that the impact on the firm's earnings for the first 2 years will cause a negative growth of 5% annually.Further,it is anticipated that the firm will then experience 2 years of zero growth,after which it will begin a positive annual sustainable growth of 6%.If the firm's required return is 10% and its last dividend,D(0),was $2 per share,what should be the current price per share?

Question

Quizplus · Accepted Answer

Step 1 - Calculate the present value of the negative-growth cash flows.
PV = 11ea7fdb_fbf5_3d4b_a768_73db7b2f3385_TB2902_11 = $1.73
PV = 11ea7fdb_fbf5_3d4c_a768_85db559f387c_TB2902_11 = $1.49
Step 2 - Calculate the present value of the zero-growth cash flows.
PV = 11ea7fdb_fbf5_3d4d_a768_3f983691f07f_TB2902_11 = $1.36
PV = 11ea7fdb_fbf5_645e_a768_a91c916b6d28_TB2902_11 = $1.23
Step 3 - Calculate the present value of the constant-growth cash flows and discount it back to today. 11ea7fdb_fbf5_645f_a768_ab90cf94d8e6_TB2902_11 = 11ea7fdb_fbf5_6460_a768_33a4e0e10685_TB2902_11 11ea7fdb_fbf5_6461_a768_592b156baad1_TB2902_11 = 11ea7fdb_fbf5_6462_a768_755176160302_TB2902_11 = $47.83
PV = 11ea7fdb_fbf5_6463_a768_0185f2f443af_TB2902_11 = $32.67
Step 4 - Add the present values together to get the current stock price.
1.73 + 1.49 + 1.36 + 1.23 + 32.67 = $38.48

NYC Company Has Decided to Make a Major Investment