Assume that the risk-adjusted discount rate on newco stock

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You expect Newco to have no earnings for the next two years. You expect Newco to have earnings of $1,000,000 in year three. Newco will pay out 2/3 of these earnings as a dividend three years from today. Newco will invest the other 1/3 back in the business in a project that yields a 15% rate of return. In fact, you expect that each year (starting in year three) Newco will be able to reinvest one-third (but not more) of its earnings in the business and achieve a return of 15%. These investment opportunities will stop in year fifteen so that beginning fifteen years from today Newco will pay out all of its earnings as a dividend at the end of each year. Assume that the risk-adjusted discount rate on Newco stock is 12%. How much should you be willing to pay for a 10% stake in Newco?

Reference no: EM131512209

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