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. |

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