Hughes Co. is growing quickly. Dividends are expected to grow at a rate of 22 percent for the next three years, with the growth rate falling off to a constant 4 percent thereafter. If the required return is 12 percent and the company just paid a dividend of $1.60, what is the current share price? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Current share price$

Introduction:

Investors are always seeking growing companies which can bring potential gains to their portfolios. Hughes Co. is one such company which has been growing rapidly in recent years. The question of determining the current share price based on certain expectations regarding dividends is what investors are looking for to make informed investment decisions.

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Description:

Hughes Co. has been experiencing rapid growth, and shareholders have been enjoying increasing dividends. According to projections, dividends are expected to continue to grow at a rate of 22 percent annually for the next three years, with the growth rate dropping off to a constant 4 percent thereafter. The required return of investors is 12 percent, and the most recent dividend paid by the company was $1.60. With these parameters, investors want to know the current share price of Hughes Co.

Using the information given, we can calculate the current share price based on the expected dividends and the required return of investors. It is important for investors to know this price so that they can make informed investment decisions regarding Hughes Co. The calculation of the current share price will provide valuable information for investors looking to invest in Hughes Co.

Objectives:

– To understand how to calculate the current share price of a company using dividend growth rate and required return.

– To learn how company growth rate affects the current share price of the company.

Learning Outcomes:

By the end of this lesson, the learners will be able to:

– Calculate the current share price of a company given the dividend growth rate and required return.

– Explain the relationship between dividend growth rate, required return and current share price.

– Analyze the effect of different dividend growth rates on the current share price of the company.

Note: This is a finance problem that can be used in a financial analysis or valuation context.

Solution 1:

One possible solution to this problem is to use the dividend discount model (DDM) to calculate the current share price. The DDM is a model used to estimate the intrinsic value of a stock based on its expected future dividends. Here are the steps to calculate the current share price using the DDM:

Step 1: Estimate the dividend per share for each of the next three years.

Dividend for year 1 = $1.60 x (1 + 22%) = $1.95

Dividend for year 2 = $1.95 x (1 + 22%) = $2.38

Dividend for year 3 = $2.38 x (1 + 22%) = $2.91

Step 2: Estimate the terminal value of the stock.

Terminal value = $2.91 x (1 + 4%)/(12% – 4%) = $51.21

Step 3: Calculate the present value of the expected dividends and the terminal value.

Present value of dividends = $1.95/(1 + 12%) + $2.38/(1 + 12%)^2 + $2.91/(1 + 12%)^3 = $5.95

Present value of terminal value = $51.21/(1 + 12%)^3 = $32.97

Step 4: Add the present values of the expected dividends and the terminal value to get the intrinsic value of the stock.

Intrinsic value of the stock = $5.95 + $32.97 = $38.92

Therefore, the current share price is $38.92.

Solution 2:

Another possible solution is to use the Gordon growth model to calculate the current share price. The Gordon growth model is a simplified version of the DDM that assumes a constant growth rate in perpetuity. Here are the steps to calculate the current share price using the Gordon growth model:

Step 1: Estimate the dividend per share for the next year.

Dividend for year 1 = $1.60 x (1 + 22%) = $1.95

Step 2: Estimate the expected future dividend growth rate and the required rate of return.

Expected future dividend growth rate = 4%

Required rate of return = 12%

Step 3: Apply the Gordon growth model formula to calculate the intrinsic value of the stock.

Intrinsic value of the stock = Dividend for year 2/(Required rate of return – Expected future dividend growth rate)

= $1.95 x (1 + 4%)/(12% – 4%)

= $38.92

Therefore, the current share price is $38.92.

Suggested Resources/Books:

1. “Fundamentals of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus.

2. “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc. and Tim Koller.

3. “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran.

Similar Asked Questions:

1. How do you calculate the current share price of a company?

2. What is the formula for calculating the required return for investments?

3. How do you determine the constant growth rate of a company’s dividends?

4. How does a company’s dividend growth rate affect its share price?

5. What is the significance of the required return in determining the value of a company’s stock?

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