Question

Micro Corp. 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. What is the value of stock two years from now? If it is trading at $55 in the market and you own it do you sell or buy more?

Answer 1

We will use the dividend discount model to calculate the value of share today. According to this model, present value of future expected dividends is value of share today.

where V3 is the terminal value of share, which is the value of constant growing dividends year after.

D1 = 2 * (1 + 5%) = 2.1

D2 = 2.1 * (1 + 15%) = 2.4150

D3 = 2.415 * (1 + 25%) = 3.0188

D4 = 3.01875 * (1 + 10%) = 3.3206

V3 = 66.4125

V0 = 1.8261 + 1.8261 + 1.9849 + 43.6673 = $49.30 --> Current Value

Market value = $55. Since market value > Current Intrinsic value we just calculated, stock is overvalued and should not be bought.

Value of stock 2 years from now would be:

V2 = 2.625 + 57.75 = $60.38