Question

Galaxy Air, previously a no-growth firm, has two million shares outstanding. Until now, it consistently earned $20 million per year on its assets. (It has no debt and pays out all earnings as dividends. Its cost of capital is 10 percent.) Due to its newly appointed CEO, Galaxy Air is now able to squeeze out 1 percent annual growth by plowing back 5 percent of earnings. Calculate its stock price per share

Answer 1

Answer: $106.61

Explanation:

The following can be deduced from the information given:

Net Income = $20

Weighted Average no. of shares = 2

Earning per share (EPS) = $20/2 = $10

DPS =(100% - 5%) of EPS

= 95% × $10 = $9.5

Growth Rate (g) = 1%

Cost of equity (Ke) = 10%

DPS1 = [9.5 × (1+0.01)] = 9.595

Price of Stock will now be

= Po = DPS1/(Ke-g)

= 9.595/(0.10-0.01)

= 106.61