Results 1 to 4 of 4

Thread: Current Stock Price Problem

  1. #1

    Exclamation Current Stock Price Problem

    Hi All!

    Here's the question:

    The Long Shot Company is planning on opening a beach resort in Prince William Sound in Alaska. They expect the global warming and the new oil slides to make this a tourist bonanza. The company expects no growth in earnings for the first two years. However, they believe that earnings will grow at a rate of 5% per year for the third and fourth year and then increase to a 10% growth rate thereafter. The firm will pay no dividends during the zero growth period; 20% dividend payout during the 5% growth period; and 40% dividend payout during the 10% growth period. If the required return on such stock is 20%, what should the current price be? [E0 = $3.00 per share].

    I have started the problem in excel, but I'm not quite sure where to go. I've calculated the EPS for the first two years, assuming the 20% return.

    Y0 = $3.00
    Y1 = $3.60
    Y2 = $4.32

    This is where I get stuck. Any help would be appreciated! (Also, this isn't actually my practice problem, I'm helping someone out with it). Thanks!

  2. #2
    Elite Member
    Join Date
    Jan 2012
    Posts
    4,445
    Given that information it is relatively easy to determine how much you could expect to earn on the investment over the years but to determine what the current price of that should be, you would also have to know how much that money could earn if you didn't make that investment but, say, deposited it in the bank. So you are missing a piece of information you need- what is the standard "bank rate" over this time?

  3. #3
    Quote Originally Posted by HallsofIvy View Post
    Given that information it is relatively easy to determine how much you could expect to earn on the investment over the years but to determine what the current price of that should be, you would also have to know how much that money could earn if you didn't make that investment but, say, deposited it in the bank. So you are missing a piece of information you need- what is the standard "bank rate" over this time?
    Unfortunately, I was given no other information Basically, everything that I have was given in the problem above, and I am stuck in determining the current price of the stock.

  4. #4
    Senior Member
    Join Date
    Nov 2012
    Location
    NM
    Posts
    1,384
    Quote Originally Posted by KzooKendrick View Post
    Hi All!

    Here's the question:

    The Long Shot Company is planning on opening a beach resort in Prince William Sound in Alaska. They expect the global warming and the new oil slides to make this a tourist bonanza. The company expects no growth in earnings for the first two years. However, they believe that earnings will grow at a rate of 5% per year for the third and fourth year and then increase to a 10% growth rate thereafter. The firm will pay no dividends during the zero growth period; 20% dividend payout during the 5% growth period; and 40% dividend payout during the 10% growth period. If the required return on such stock is 20%, what should the current price be? [E0 = $3.00 per share].

    I have started the problem in excel, but I'm not quite sure where to go. I've calculated the EPS for the first two years, assuming the 20% return.

    Y0 = $3.00
    Y1 = $3.60
    Y2 = $4.32

    This is where I get stuck. Any help would be appreciated! (Also, this isn't actually my practice problem, I'm helping someone out with it). Thanks!
    The way I read it, it is the $3 that remains constant the first 2 years and then grows. You need a column in the spreadsheet for E, with a formula relating to the preceding year - that formula will change with year number.

    You need a column with dividend rate.

    You need a column with book value, which will increase due to earnings and decrease as dividends are paid out. What the question is asking for is the initial value in that column.

    How do you think they define "return is 20%"? I suppose that is per year - does that mean the average over all time, or a limiting rate after a long time, or ?? Is it the dividend rate? Dividends plus retained earnings? Something else? Not my field, so I'm not sure of the jargon.
    DrPhil (not the TV guy)
    If we knew what we were doing,we wouldn't have to do it

Tags for this Thread

Bookmarks

Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •