Question

As you all know, Corona virus has created significant uncertainty and economic hardships for everyone throughout the world. The impact is felt by all companies – no one is spared. And XYZ Corporation is no exception.

A darling of investors, XYZ is a well-established firm that has paid steadily growing dividends since the 1960s.   In March 2020, the firm paid their 2019 annual dividend of $17.50 per common share. The fiscal year of XYZ Corporation runs April – March.

Because of the pandemic, Wall street and the rest of financial market expect the firm to pay no dividends for next two years until the Corona scare disappears. Afterwards, the firm is expected to have fantastic growth for the next 6 years resulting in following (abnormal) dividends for those 6 years: $9.00, $14.00, $23.00, $32.00, $38.00 and $44.00. After that time, the dividend is expected to be $20 in the first year and expected to grow at 4% per year forever.

You are thinking of investing in XYZ Corporation.

Your target is to earn 11.5% on your investment, what is the stock worth today, April 1, 2020?

For this problem - today is April 1, 2020. Also, the term “year” used above refers to the firm’s fiscal years that run April – March.

Answer 1

Given D1 and D2=0 (dividends for next two years are zero)

D3=$9.00

D4=$14.00

D5=$23.00

D6=$32.00

D7=$38.00

D8=$44.00

D9=$20

D10=$20*(1+4%)=$20.8

Terminal value at Year9=D10/(target rate-growth rate)=$20.8/(11.5%-4%)=$277.33

Value of the stock worth today=(D1/(1+11.5%))+(D2/(1+11.5%)^2)+(D3/(1+11.5%)^3)+(D4/(1+11.5%)^4)+(D5/(1+11.5%)^5)+(D6/(1+11.5%)^6)+(D7/(1+11.5%)^7)+(D8/(1+11.5%)^8)+((D9+Terminal value at year9)/(1+11.5%)^9)

=0+0+(9/1.115^3)+(14/1.115^4)+(23/1.115^5)+(32/1.115^6)+(38/1.115^7)+(44/1.115^8)+(297.33/1.115^9)

=6.49+9.06+13.35+16.65+17.74+18.42+111.63

=$193.33

Value of the Stock today=$193.33