Blog: ACC501 GDB No. 2 Solution

Solution:

Chain Reaction, Inc., has been growing at a phenomenal rate of 30% peryear. 

•You believe that this rate will last for only three more years.

•Then, you think the rate will drop to 10% per year.

•Total dividends just paid were $5 million. 

•The required rate of return is 20%. 

•What is the total value of Chain Reaction, Inc.?

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Total Marks 2

Starting Date Tuesday, January 11, 2011 

Closing Date Wednesday, January 12, 2011 

Status Open

Question/Description 

• Consider a company ABC has been growing at a phenomenal rate of 35% per year. You expect that this growth rate to last for 2 years and the rate will then drop to 10% per year. The growth rate then remains at 10% indefinitely.
  
  
  • Total dividends just paid were Rs.5 million and required return is 25%.
    Calculate the total dividend over the supernormal growth period (year 1 and year 2) and the price at year 2.
    Note: calculations are not required, only answers are required.
    
    
    Solution:
    
    
    Solution is as under:-
    Dividends
    Year 1: $ 6.75 million
    Year 2: $ 9.1125 million
    
    Price at year 2: $ 66.82
    ...............
    First Calculate the total dividends over the supernormal growth period
    
    Year Total Dividend: (in $millions)
    1 5 * 1.35 = 6.75
    2` 6.75*1.35= 9.1125
    Using the long run growth rate g the value of all the shares at time 2 can be calculated as:
    V (2) = [D (2)*(1+g)] / (k-g)
    
    V (2) = [9.1125*1.10] / (.25-.10) = $66.825