Andy N. answered • 07/08/19
Finance Practitioner/Professor for Finance, Accting and Excel Tutoring
Rather than answer your exact question here is a similar problem you can use to work your problem:
A stock just paid a dividend this morning of $1.00. Dividends are expected to grow at 10.00% for the next two years. After year 2, dividends are expected to grow at 6% for the following three years. At that point, dividends are expected to grow at a rate of 4.00% forever. If investors require a return of 10.00% to own the stock, what is its intrinsic value?
Step 1: Since the dividend was just paid you need to determine the dividends in the future to utilize for the present value calculation to arrive at intrinsic value. The year 1 dividend will be $1.00 x 1.1 = $1.10, and the year 2 dividend will be $1.10 x 1.1 = $1.21. The year 3 dividend will be $1.21 x 1.06 = $1.2826, year 4 will be $1.2826 x 1.06 = $1.3596, and year 5 will be $1.4411.
Step 2: Determine the end of year 5 present value of the growth dividend perpetuity = (1.4411 x 1.04)/(.10 - .04) = 24.9796 formula is (year 5 dividend x (1+ perpetuity growth rate)) / (required rate of return - perpetuity growth rate)
Step 3 - determine present value of all the cash flows. The present value formula for year is dividend for the year / (1+required rate of return)^year number
PRESENT VALUES BY YEAR:
- 1.1/(1.1)^1 = $1
- 1.21/(1.1)^2 = $1
- 1.2826/(1.1)^3 = .9636
- 1.3596/(1.1)^4 = .9286
- 1.4411/(1.1)^5 =.8948 + the present value of the end of year 5 perpetuity growth dividend $15.5104 (24.9796 /(1.1)^5) = $16.4052
Add the present values calculated for years 1 through 5 to get stock instrinsic value of $21.19
