1. Valuation using the dividend discount model: OnlineOne’s IPO is scheduled for tomorrow. You sit down with management and figure out a price that it can sell at. You believe that OnlineOne will pay its first dividend in 6 years. At that point it will pay a dividend of 1.80, which it will then increase at 5% each year. You think that the appropriate discount rate (equity cost of capital) for the company is 9%.

a. Based on your analysis, what is the predicted price of OnlineOne today?

b. You suggest a price of 26 for OnlineOne. Given this price, what is the projected return on the first day of trading, assuming that market participants share your views and price the stock equal to the predicted price from a.?

c. What do you expect the stock price to be in five years (one year before the first dividend payment)? In fact, OnlineOne’s stock price is equal to 36. You think that the reason is that market participants have updated their expectation about the equity cost of capital. At what rate rE would this be the correct price (assuming nothing else has changed, so that the first dividend is still expected to be 1.80)?

d. You change your mind. Instead, you now think that the dividend growth rate was too optimistic. At what level g would the price in five years be correct assuming the original level of rE (and a first dividend payment of 1.8)?