Question

1) The company Old Co has a current stock price of $210 per share. Last year they paid an

annual dividend of $10 per share. Historically the dividend growth was 5% per year; the next dividend payment will be $10.50. What is the discount rate implied by this firm?

2)A competitor NewCo enters the market (same good, same technology, same market). The

company says they do not plan to pay a dividend for the first five years. Instead, they plan to

use the cash to make strategic acquisitions into new businesses. The company says they will

pay a dividend at the end of year 6 of $20 and then grow the dividend by 5% a year. What is

the present value of NewCo using the discount rate of OldCo?

Answer 1

1.Gordon Growth Model:

$P=\frac{D}{r-g}$

$210=\frac{10.5}{r-0.05} ​$

r=0.1, 10%

2.Gordon Growth Model:

$P=\frac{D}{r-g}$

$P=\frac{20}{0.1-0.05}=400$