Suppose that sales and profits of Anli Enterprises are growi

Suppose that sales and profits of Anli Enterprises are growing at a rate of 25% per year. At the end of four years the growth rate will drop to a steady 4%. At the end of year 5, Anli will issue its first dividend in the amount of $3.50 per share. If the required return on Anli’s stock is 14%, what is the value today of a share of Anli\'s stock? Assume dividends grow at the same rate as earnings after year 4. Also, please show how to entering number in financial calculator HP 10bII+

Solution

In the given question, Required rate of return on stock is assumed to be Ke (COst of equity).

The question is solved using Variable Divided Growth Model which is calulated as per the following formula:

P₀=[D₀ (1+g)/ K_e-g+D₀ (1+g)²/ K_e-g........D₀ (1+g)ⁿ/ K_e-g]+P_n/(1+K_e)ⁿ

D₀= 0

g=25% (for year 1-3)

g=4% (From year 4)

D₅= $3.5

K_e= 14%

P4= 35 ( As per Gordon\'s Growth Model; 3.5/(0.14-.04)= 35 )

Price of the stock for 4^th year end is calculated using Gordon\'s Divided growth model where Divided for year 5 is cosidered.

As per the above discussed formula, since there is no dividend till year 4, only P4 shall be perenially discounted. Therefore;

35/(1+0.14)⁴= $ 20.72.