Question

Communications Fiji Limited just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5% next year, 15% in year two, and 25% in year 3. After that growth is expected to level off to a constant growth rate of 10% per year. The required rate of return is 15%. Calculate the intrinsic value using the multistage model.

Answer 1

D0	2
For the first three years
g1	0.05
D1	2*(1+.05)
D1	2.1
g2	0.15
D2	2.1*(1+.15)
D2	2.415
g3	0.25
D3	2.415*(1+.25)
D3	2.677
Find the price of the stock in year 3
g4	0.1
D4	2.677*(1+.1)
D4	2.9447
According to the dividend growth model.
P3 = D4/(R-g4)
R is the required return that is 15%.
P3	2.9447/(.15 - .1)
P3	58.894
Cash flow in year 3	P3 +D3
Cash flow in year 3	61.571
The price of the stock today = sum of present value of future cash flows.
Using R = .15
Year	1	2	3
Cash flow	2.1	2.415	61.57088
Present value	1.83	1.83	40.48
sum of present values	44.14
The intrinsic value of the stock is $44.14.