Question

Nut and Bolt Guy, Inc.'s stock carries an expected return of 11%. The firm will pay a $2.4 dividend next year.  
After year 1, the dividend is expected to grow by 5% percent for years 2 and 3. The firm expects the dividend to grow by 3% after year 3.

Given this information, what is the intrinsic value of the stock?

		$51.7
		$42.4
		$37.7
		$31.1

Answer 1

The value of the stock is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 2.4 / 1.11 + ($ 2.4 x 1.05) / 1.11² + ($ 2.4 x 1.05²) / 1.11³ + 1 / 1.11³ x [ ($ 2.4 x 1.05² x 1.03) / (0.11 - 0.03) ]

= $ 2.4 / 1.11 + $ 2.52 / 1.11² + $ 2.646 / 1.11³ + $ 34.06725 / 1.11³

= $ 2.4 / 1.11 + $ 2.52 / 1.11² + $ 36.71325 / 1.11³

= $ 31.10

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