Question

Please do not use excel to resolve this exercise, abd the answer is $47.18

thanks!

Finance 4200 In Class Problem Two Stage Growth Firm A just paid a dividend of $2.50 per share. This dividend is expected to grow at a rate of 18% over the next three years and then grow at a rate of 3% after that into the foreseeable future. If Firm A's cost of equity is 11 percent, estimate the intrinsic value of its common shares today.

Answer 1

Step 1:

g = Growth rate = 18% for 3 years and 3% forever thereafter

ke = required rate of return =cost of equity = 11%

Current Dividend per share =D0 = $2.5

Dividend in 1st year = D1 = D0* (1+g) = $2.50 * (1+18%) = $2.95

Dividend in 2nd Year = D2 = D1 * (1+g) = $2.95 *(1+18%) = $3.481

Dividend in 3rd year = D3 = D2 * (1+g) = $3.481 * (1+18%) = $4.10758

Dividend in 4th year = D4 = D3 * (1+g) = $4.10758 * (1+3%) = $4.23081

Horizon value at the year 3 for years 4 to forever =H = D4 / (ke - g) = $4.23081 / (11% - 3%) = $52.88513

Step 2:

Current share price = present value of dividends paid

= [D1 / (1+r)^1] + [D2 / (1+r)^2] + [D3 / (1+r)^3] + [H / (1+r)^3]

= [$2.95 / (1+11%)^1] + [$3.481 / (1+11%)^2] + [$4.10758 / (1+11%)^3] + [$52.88513 / (1+11%)^3]

= [$2.95 / 1.11] + [$3.481 / 1.2321] + [$4.10758 / 1.367631] + [$52.88513 / 1.367631]

= $2.657658 + $2.825258 + $3.003427 + $38.669151

= $47.155494

Therefore, Current share price is $47.16