a) You are a stock analyst in charge of valuing high-technology firms, and you are expected to come out with buy-sell recommendations for your clients. You are currently analyzing a firm called etalk.com that specializes in internet-based communication. You are expecting explosive growth in this area. However, the company is not currently profitable even though you believe it will be in the future. Your projections are that the firm will pay no dividends for the next 2 years. Three years from now, you expect the stock to pay its first dividend of $1.50 per share. You expect dividends to increase at a rate of 10 percent per year for two years after that. At that point, the industry will start to mature and growth will slow down; dividends will continue to grow at a rate of 5 percent per year for the foreseeable future.
The stock is trading on the Sauder Stock Exchange for $15 per share. If you believe that the required rate of return is 12 percent, what is your estimate of the value of the stock, and should you issue a recommendation to buy or to sell?n

b) The day after you make your estimate in part (a), new information indicates that things are not going as smoothly as predicted for this business. Your estimates of the initial dividend and the growth rates remain the same, but the timing has changed. You now estimate that the firm will pay its first dividend ($1) in 6 years. The high-growth period (20 percent per year) will last for only two years before slowing to growth of 10 percent per year for the foreseeable future. Given a required rate of return of 14 percent, what is your new estimate of the value of the stock? Should you change your recommendation (assuming the stock is still priced in the market at $20)? 

Answer rating: 100% (QA)

Part A The value of the share as per Gordon Model Dividend discount Model is the present value of al... View the full answer