HRM manufactures state of the art sound systems targeted at the young professional market. Analysts following HRM Corporation predict that the company’s earnings and dividends will continue to grow at 14 percent for the next period. After that, growth will level off at 5 percent for the indefinite future. Last year’s dividend was $2 per share and analysts figure that the required return on this stock should be 14 percent.
What is the value of an HRM share (=Present Value of future dividend payments) assuming that growth at the rate of 14 percent will continue for seven years?
What is the value of an HRM share assuming that growth will drop immediately (starting year 1 it drops to 5%) to the long-run rate of 5 percent?
NOTE: Draw a time line for question number 5 a and b.