Question

Due to the devastating economic impact of the global pandemic, a firm just announced that over the next two years it will pay a reduced dividend of $1.50 per year. Three years from today it expects to pay a dividend of $4.60 and thereafter dividends are expected to grow at a constant annual growth rate of 1.4%. Assuming a discount rate of 9%, calculate the fair value of the firm's stock today.

Answer 1

The value of the stock is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 1.50 / 1.09 + $ 1.50 / 1.09² + $ 4.60 / 1.09³ + 1 / 1.09³ x [ ($ 4.60 x 1.014) / (0.09 - 0.014) ]

= $ 1.376146789 + $ 1.26251999 + $ 3.552044008 + 1 / 1.09³ x ($ 4.6644 / 0.076)

= $ 1.376146789 + $ 1.26251999 + $ 3.552044008 + $ 61.37368421 / 1.09³  

= $ 1.376146789 + $ 1.26251999 + $ 3.552044008 + $ 47.39174506

= $ 53.58 Approximately