Question

Aphrodite Corporation’s common stock is selling at 120 dollars a share. It just paid a dividend of 6 dollars. Investors expect a return of 20% on their investment on Aphrodite’s common stock.

1. From this information what is the expected growth of future dividends?
2. What is the Dividend Yield?
3. The stock is traded at the NASDAQ Exchange with the Quoted Price of 33 dollars. Is the stock Overvalued/Undervalued?
4. What will be the price of the Aphrodite’s stock five years from now?
5. What are the limitations of this particular model?

Answer 1

Solution

1.

Present value = [current dividend * (1 + g)] / R - g

=> 120 = 6 ( 1 + g) / (0.20 - g)

=> 120 (0.20 - g) = 6 (1 + g)

=> 24 - 120 g = 6 + 6g

=> 126g = 18

=> g = Expected growth of future dividends = 14.3%

2.

Dividend Yield is computed as

D1 / P = [6 ( 1 + 0.143)] / 120 = 6.858 / 120 = 5.72%

3.

As the current price of  $120 per share is more than the Nasdaq exchange quoted price of $33, then the stock is under-valued.

4.

D(n) = Present dividend * (1 + future dividend growth)^n

= (1 + 0.143)^6 = 6 * 2.23 = $13.38

P5 = Stock price five years from now = D6 / R - g = 13.38 / (0.20 - 0.143) = $234.74

5.

This model assumes that growth is constant throughout the period of payments which is not the actual case in a real-time scenario