Question

Find the intrinsic value of the stick that pays a fividend of $3.23 and has a growth rate of 8.5% for 4 years then it stabalizes at a long-tun growth rate of 3%. The stock has a beta of 2.2, the risk free rate is 1.5%, and the market return is 7%.

Answer 1

Year 1 dividend = 3.23 (1 + 8.5%) = 3.50455

Year 2 dividend = 3.50455 (1 + 8.5%) = 3.802437

Year 3 dividend = 3.802437 (1 + 8.5%) = 4.125644

Year 4 dividend = 4.125644 (1 + 8.5%) = 4.476324

Year 5 dividend = 4.476324 (1 + 3%) = 4.610613

Required rate = Risk free rate + beta(market return - risk free rate)

Required rate = 1.5% + 2.2(7% - 1.5%)

Required rate = 1.5% + 12.1%

Required rate = 13.6%

Value at year 4 = D5 / required rate - growth rate

Value at year 4 = 4.610613 / 0.136 - 0.03

Value at year 4 = 4.610613 / 0.106

Value at year 4 = 43.4963

Intrinsic value = Present value of cash flows

Intrinsic value = 3.50455 / (1 + 0.136)^1 + 3.802437 / (1 + 0.136)^2 + 4.125644 / (1 + 0.136)^3 + 4.476324 / (1 + 0.136)^4 + 43.4963 / (1 + 0.136)^4

Intrinsic value = $37.65