Question

Four years ago, Delta Co , paid dividends equal to 0.40 USD per share.Today, the same company paid dividends 0.90 USD per share.

The company’s past dividend policy led to steady dividend growth rates of (g1). The company is expected to maintain the same dividend policy for the next three years. After three years, the company’s dividend growth rate (g2) is expected to be 8% flat for the foreseeable future.

Taking into account that investors require a return of 14% in order to invest in Delta's stocks

What is the intrinsic value of Delta's Stocks using Dividend Discount Model and if the market currently prices of Delta Stock is 30 , would you put money in Delta?

Answer #1

Cost of equity is the deciding factor for a company to check whether an investment meets capital return requirement.

Hence here r=0.14

Some standard results used here are

Sum of an geometric progression :

S = a + ar + +ar^{2} + .... + ar^{n} =
a(r^{n+1}-1)/(r-1) ........... used in the case of
'g_{1}'

and when r < 1 and n tends to infinity

S_{infinity} = a/(1-r) ....... used in case of
'g_{2}'

Their proofs can be found in any standard textbooks.

Thank you.

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