Brittney and Kim Wan Sun have successfully launched a successful talent agency, ABC. They expect the firm’s earnings and dividends to grow by 20% annually for the next 10 years and they establish a strong base and to grow at a constant 5% per year thereafter. ABC uses a 12% discount rate. Dividends are paid annually, for computational convenience. The next annual dividend of $10 will be paid exactly one year from today.
a. What is the price of a share of ABC?
b. Suppose Kofi market insight analysts thing ABC can only grow at 20% for 5 years, not 10, after which growth will stay at 5% indefinitely. What value would the Kofi analysts put on a share of ABC? Informally, is the stock valuation very sensitive to the length of the initial growth period?
c. Suppose another valuation service – Values R Us, believes that ABC forecasts are good in the near term (they believe that dividends will grow at 20% for 10 years as stated) but less good in the long term – they predict that dividends will grow at 3% rather than 5% indefinitely. What is their valuation of a share of ABC? Informally, is the stock valuation very sensitive to the long run growth rate?