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MGM Enterprises expects earnings and dividends to grow at a rate of 25% for the next...

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Finance

MGM Enterprises expects earnings and dividends to grow at arate of 25% for the next 4 years, after that the growth rate inearnings and dividends will fall to zero, i.e., g = 0. Thecompany's last dividend, D0, was $1.25, its beta is1.20, the market risk premium is 5.50%, and the risk-free rate is3.00%. What is the current price of the common stock?

Answer & Explanation Solved by verified expert
4.5 Ratings (652 Votes)

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 3 + 1.2 * (5.5)
Expected return% = 9.6
Required rate= 9.60%
Year Previous year dividend Dividend growth rate Dividend current year Horizon value Total Value Discount factor Discounted value
1 1.25 25.00% 1.5625 1.5625 1.096 1.4256
2 1.5625 25.00% 1.953125 1.953125 1.201216 1.62596
3 1.953125 25.00% 2.44140625 2.44140625 1.316532736 1.85442
4 2.44140625 25.00% 3.051757813 31.789 34.84075781 1.442919879 24.14601
Long term growth rate (given)= 0.00% Value of Stock = Sum of discounted value = 29.05
Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 4 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

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Transcribed Image Text

MGM Enterprises expects earnings and dividends to grow at arate of 25% for the next 4 years, after that the growth rate inearnings and dividends will fall to zero, i.e., g = 0. Thecompany's last dividend, D0, was $1.25, its beta is1.20, the market risk premium is 5.50%, and the risk-free rate is3.00%. What is the current price of the common stock?

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