Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 22% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i. e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock? a. $32.69
b. $26.57
c. $27.37
d. $28.97
e. $23.39

Option B ,$26.57 is correct

Explanation:

The cost of equity =Rf+Beta*Mrp

Rf is the risk free rate of 3.00%

Beta of equity is 1.20

Mrp is the market risk premium which is 5.50%

Cost of equity=3.00%+(1.20*5.50%)=9.60%

Stock price =present value of dividends+present value of terminal value

D1=$1.25*(1+22%)/(1+9.6%)^1=$ 1.39

D2=$1.25*(1+22%)^2/(1+9.6%)^2=$ 1.55  

D3=$1.25*(1+22%)^3/(1+9.6%)^3=$ 1.72  

D4=$1.25*(1+22%)^4/(1+9.6%)^4=$ 1.92  

terminal value=year 4 dividend/(r-g)

year 4 dividend=$1.25*(1+22%)^4= 2.77  

r is the cost of equity of 9.6%

g is the dividend afer year 4 which is 0%

terminal value= 2.77/(9.6%-0%)=$ 28.85  

present value of terminal value= 28.85/(1+9.6%)^4=$ 19.99  

Total present values=$ 1.39+$ 1.72+$ 1.92  +$ 1.92 +$ 19.99  =$26.58

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