Reference no: EM132575417
Assume you expect a company's net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company's β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding.
Except the growth rates are 5% for years 2 and 3 and then 3% perpetually for all future years.
Question a. Compute D1, D2, D3 and the growth in D for all future years.
Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2 and 3, and then increases by 3% in all future years; and keeping in mind that beginning of year 1 common equity is $8,000, increases by 5% at the beginning of year 2 and at the beginning of year 3, and then increases by 3% at the beginning of all future years, you should be able to compute: D1 = $700, D2 = $735, D3 = 948.15, and D4 = 976.59, D4/D3-1=3%, and D for all future years using the 3% constant growth rate.
Question b. How to calculate D3 and D4
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