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5 October, 15:20

Sultan Services has 1.4 million shares outstanding. It expects earnings at the end of the year of $ 5.20 million. Sultan pays out 60% of its earnings in total - 40% paid out as dividends and 20% used to repurchase shares. If Sultan's earnings are expected to grow by 55 % per year, these payout rates do not change, and Sultan's equity cost of capital is 10%, what is Sultan's share price?

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  1. 5 October, 18:50
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    Answer: $49.52

    Explanation:

    To solve this we can use the Gordon Growth Model of Stock Valuation because the growth rate is constant.

    The formula goes like this,

    Value of stock = D1 / r - g.

    D1 = the annual expected dividend of the next year.

    r = rate of return or cost of capital.

    g = the expected dividend growth rate (assumed to be constant)

    First we'll calculate the next dividend/pay out which is 60% of earnings.

    = 5.2 million * (0.6)

    = $3.12 million.

    Putting the figures into the formula would give us (we will assume the growth rate of 55% written there is a typo because such a growth rate vs that Equity cost of capital is implausible and instead use a growth rate of 5.5%),

    Value of stock = D1 / r - g.

    = 3.12 / (0.1 - 0.055)

    = $69.33 million

    To find the share drive we will then divide the total value of stock by the number of shares outstanding.

    = 69.33/1.4

    = $49.52

    Sultan's Share Price is therefore $49.52
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