What is the present value of P7 at the beginning of year 1?

What is the present value of P7 at the beginning of year 1?

You are considering an investment in the
shares of Kirk’s Information Inc. The company is still in its growth phase, so
it won’t pay dividends for the next few years. Kirk’s accountant has determined
that their first year’s earnings per share (EPS) is expected to be $20. The
company expects a return on equity (ROE) of 25% in each of the next 5 years but
in the sixth year they expect to earn 20%. In the seventh year and forever into
the future, they expect to earn 15%. Also, at the end of the sixth year and
every year after that, they expect to pay dividends at a rate of 70% of
earnings, retaining the other 30% in the company. Kirk’s uses a discount rate
of 15%.

A. Fill in the missing items in the
following table:

Year

EPS

ROE

Expected Dividend
(end of year)

Present Value Of Dividend
(at time 0)

0

n/a

n/a

n/a

n/a

1

20

25%

0

0

2

25 =
1.25 x 20

25%

0

0

3

?

25%

0

0

4

?

25%

0

0

5

?

25%

0

0

6

?

20%

?

?

7

?

15%

?

?

8

?

15%

?

?

B. What would the dividend be in year 8?

C. Calculate
the value of all future dividends at the beginning of year 8. (Hint: P7
depends on D8.)

D. What
is the present value of P7 at the beginning of year 1?

E. What is the value of the company now, at time
0?


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