Question

Assume that a stock, Initex in the market at $45. beta=1.25, rate of market premium Rm=20%, Risk-free rate Rf=8% and the stock is a non-constant growth stock, that pays the following dividends. Do=3.24, D1=3.80, D2=5.160 and after that dividends are expected to grow indefinitely at the constant rate of 12%.

a) What is the fair value of the stock?

b) If you believe your valuation model what should you do?

c) What percentage of the intrinsic value can be attributed to the long -term?

d) What portion can be attributed to abnormal growth?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

B -Nm $45 Market Price of stock Beta Market risk premium Risk free rate Required rate of return 1.25 20% 8% 33.00% Constant growth rate after year 2 12.00% Year 1 Dividend 3.800 5.160 5.779 PV of Dividend of abnormal growth period Terminal value at end of year 2 PV of Terminal value $5.77 $27.52 $20.69 17 19 a. Fair Value of Stock $26.47 20 21 b. You Should not this stock because its Market price is more than its fair value thus it is overvalued. 23 24 c. % of intrinsic value attributed to the long-term L 78.18% 25 26 27 d. Portion attributed to abnormal growth 21.82% 28 29

Cell reference -

в 45 1.25 Market Price of stock Beta Market risk premium Risk free rate Required rate of return 0.2 0.08 =C5+C3*C4 Constant growth rate after year 2 0.12 Year Dividend 3.8 5.16 =C12*(1+C8) 2 PV of Dividend of abnormal growth period Terminal value at end of year 2 PV of Terminal value =NPV(C6,C11:012) =C13/(C6-C8) =C16/(1+C6) Fair Value of Stock =C15+C17 b. You Should not this stock because its Market price is more than its fair value thus it is overvalued. % of intrinsic value attributed to the long-term =C17/C19 d. Portion attributed to abnormal growth =1-C25

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.