On January 1,1991,you Are Considering Buying Stock in Genetic Biology

Essay

On January 1,1991,you are considering buying stock in Genetic Biology Systems (GBS),which has just announced a new type of corn that will provide nitrogen to the soil and thus eliminate the need for additional fertilizer.GBS had an EPS of $1.20 in 1990.The firm's expected annual growth rate is 50% for 1991 and 1992,25% for the following two years,and 10% thereafter.Its dividend payout ratio is expected to be zero in 1990 and 1991,to rise to 20% for the following two years,and then to stabilize at 50% thereafter.The risk-free rate is 15%,and GBS has a beta of 1.2.The market rate of return is 16%.
a. What is the value of GBS stock?
b. Now assume that you are in the 40% tax bracket but that capital gains are taxed at 16%. Assume that you can buy GBS stock for $22.26. You can also buy the stock of ISD, Inc., which is of equal risk to GBS and sells for $42.86. ISD has just paid a dividend of $6, and has an expected constant growth rate of 2%. If you plan to hold either investment for four years and then sell it, which stock is a better investment for you?