Question

Consider the stock information for the upcoming IPO (initial public offering) for Lyft. Expected IPO stock price = $120/share Expected cash dividend next year $3.00/share This dividend amount is expected to grow by 10% each year The expected stock price after 3 years is $140/share The market interest rate is 6%. Draw the cash flow and write out an equation to see if it’s a good idea to buy this stock. Is it a good idea? (Find the present value of the future stock price and the dividends). If you put your money in the bank how much will you have at the end of the 3 years period? Is this amount less than or greater than $140? Does this change your conclusion?

Answer 1

*Answer:

Dividends paid over 3 years: D1 = 3; D2 = 3*(1+10%) = 3.30; D3 = 3.30*(1+10%) = 3.63

Stock price at t = 3 is 140

Total cash flow: CF1 = 3; CF2 = 3.30; CF3 = 3.63 + 140 = 143.63

PV of cash flows = 3/(1+6%)^1 + 3.30/(1+6%)^2 + 143.63/(1+6%)^3

= 2.83 + 2.94 + 120.59 = 126.36

Since the IPO price is 120, it is undervalued so it should be bought.

*If $120 is invested at market interest rate for 3 years, the amount after 3 years will be 120*(1+6%)^3 = 142.92

* This amount is greater than the stock price of $140 after 3 years but that does not change the conclusion of buying the Lyft share since dividend income is not being considered here. Total return from the share is higher than the market investment.

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