Question

Suppose that Apple Inc. (AAPL) is selling for $280.00. Analysts believe that the growth rate for AAPL will be 25% per year for the next three years, 15% per year for the following two years, and thereafter the growth rate will be 8% indefinitely. AAPL’s most recent cash dividend per share was $3.00. The dividend will grow by the same rate as the company. Stockholders require a return of 10 percent on AAPL’s common stock.
Required:
Based on the above assumptions, determine the price of AAPL’s common stock.  
Explain whether an investor should buy the stock.

Answer 1

We will use the discounted cash flow approach here to value Apple. The first 3 years' dividend will be 3 x 1.25 = $3.75, 3.75 x 1.25 = 4.6875 and 4.6875 x 1.25 = 5.8593. The next two years' dividend will be 5.8593 x 1.15 = 6.7382 and 6.7382 x 1.15 = 7.749. To calculate the terminal value, we will use the Gordon growth formula written as:

Terminal Value = Div x (1+g)/(r-g) = 7.749 x 1.08/(0.1 - 0.08) = 418.446.

Now, we use the discounted cash flow method to find the intrinsic value of the stock:

3.75/1.1 + 4.6875/1.1^2 + 5.8593/1.1^3 + 6.7382/1.1^4 + 7.749/1.1^5 + 418.446/1.1^5 = 280.921

Hence, the stock price should be $280.921 per share and therefore an investor shouldn't buy the stock as the intrinsic value is almost same as the market price.