Question

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?

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.**

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