Question

QUESTION 10 A common stock just paid a $2.00 dividend that will grow at 7% for year 1, then at 3% for years 2 and 3, then at 2% thereafter. Using a required return of 8%, what is the intrinsic value of the common stock?

		$36.31
		$33.33
		$29.36
		$31.25
		none of these

Answer 1

Answer is $36.31

Current Dividend, D0 = $2.00

Growth for first year is 7%, for next two years is 3% and a constant growth rate (g) of 2%

D1 = $2.00 * 1.07 = $2.14
D2 = $2.14 * 1.03 = $2.2042
D3 = $2.2042 * 1.03 = $2.2703
D4 = $2.2703 * 1.02 = $2.3157

Required Return, rs = 8%

P3 = D4 / (rs - g)
P3 = $2.3157 / (0.08 - 0.02)
P3 = $2.3157 / 0.06
P3 = $38.5950

P0 = $2.14/1.08 + $2.2042/1.08^2 + $2.2703/1.08^3 + $38.5950/1.08^3
P0 = $36.31

Therefore, intrinsic value of the common stock is $36.31