Swink Electric, Inc., has just developed a solar panel capable of generating 200 percent more electricity than any solar panel currently on the market. As a result, Swink is expected to experience a 15 percent annual growth rate for the next five years. When the five-year period ends, other firms will have developed comparable technology, and Swink’s growth rate will slow to 5 percent per year indefinitely. Stockholders require a return of 12 percent on Swink’s stock.
The firm’s most recent annual dividend (D0), which was paid yesterday, was $1.75 per share.
a. Calculate Swink’s expected dividends for the next five years.
b. Calculate the value of the stock today. Proceed by finding the present value of the dividends expected at the end of the next five years plus the present value of the stock price that should apply at the end of Year 5. You can find the Year 5 stock price by using the constant growth equation (Equation). To find the Year 5 price, use the dividend expected in Year 6, which is 5 percent greater than the Year 5 dividend.
c. Calculate the dividend yield, D1 P0, the expected capital gains yield, and the expected total return (dividend yield plus capital gains yield) for this year. (Assume that P0 = P0, and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Calculate these same three yields for Year 5.
d. Suppose your boss believes that Swink’s annual growth rate will be only 12 percent during the next five years and that the firm’s normal growth rate will be only 4 percent. Without doing any calculations, explain the general effect that these growth-rate changes would have on the price of Swink’s stock
e. Suppose your boss also regards Swink as being quite risky and believes that the required rate of return for this firm should be 14 percent, not 12 percent. Without doing any calculations, explain how the higher required rate of return would affect the price of the stock, its capital gains yield, and its dividend yield.