Question

A share of DRV, Inc., stock is expected to pay no dividend for the upcoming 3...

A share of DRV, Inc., stock is expected to pay no dividend for the upcoming 3 years. Then, end of year 4, it is expected to pay a dividend of $10. The dividend is expected to grow at a constant rate of 4% for two additional years and then stabilize at 2%.The required rate of return is 12%. Suppose a DRV stock is selling for $30 today.

1- Calculate the current expected rate of return on DRV stock

2- Will you buy DRV stock today?

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Answer #1

Solution:- Given in Question:-

Stock price selling today = $30

Required Rate of Return(Ke) = 12%

DPS4 = $10

DPS5 = DPS4 ( 1 + Growth Rate)

DPS5 = $10 ( 1 + 0.04)

DPS5 =$10.40

DPS6 = DPS5 ( 1 + Growth Rate)

DPS6 = $10.4 ( 1 + 0.04)

DPS6 =$10.816

DPS7 = DPS6 ( 1 + Growth Rate)

DPS7 = $10.816 ( 1 + 0.02)

DPS7 =$11.032

Terminal Value at the end of year 6 =

Terminal Value at the end of year 6 =

Terminal Value at the end of year 6 = $110.32

Fair Price of Stock today-

Expected Rate Of Return = = 145.43%

B. Yes, It is beneficial to buy the DRV stock today as it is undervalued.

If you have any query related to question then feel free to ask me in a comment. Thanks. Please rate.

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