Green Mountain, Inc. just paid a dividend of $3.50 per share (D0 = $3.50) on its stock. The dividends are expected to grow at a constant 6 percent per year indefinitely. If investors require a 13 percent return on the stock,
a. What is the current price?
Po= 3.50(1.06)/.13-.06= 3.71-.07= $53
b. What will the dividend be in 4 years? In 16 years?
P4= 53(1.06^4)= $66.91
P16= 53(1.06^16)= $134.64
c. What will the price be in 3 years? In 15 years?
P3= 53(1.06^3)= $63.12
P15= 53(1.06^15)= $127.02
d. Find the dividend yield and capital gains (or loss) yield.
e. Sum dividend yield and capital gains yield. Does your number match with the required rate of return given above?
f. Suppose that demand for Green Mountain’s products unexpectedly falls off. As a result, the expected growth rate declines to 4%. Holding everything else constant, now what should the value of the stock be? Does new stock price make sense to you?
Given information in the first question, the firm’s managers plan to invest in some large, risky projects next year. As a result, the required return on the common stock will increase to 14%. However, the expected growth rate will increase to 8%. Holding everything else constant, should they undertake these projects? What if the required return will increase to 16% and the expected growth rate will increase to 8%?