Question

7) Firm D just paid a dividend of $2.00, and its dividend is expected to grow at 30% for the next year, and 15% the year after. Starting from the third year, the firm will pay $3.50 every year. Your required rate of return for this firm is 10%. What is the intrinsic value of the stock?

Answer 1

Firm D just paid a dividend of $2.00.
In Year 1 the dividend would be = 2 * 1.30
= $2.60
In year 2 dividend would be = 2.60 * 1.15
   = $2.99
From year 3 dividend would be $3.50 every year.

Present value of dividends at the end of 2nd year of all future dividends would be
= D1 / k    (where, k is the required rate of return and D is 3.50)

= 3.50 / 0.10 (where 0.10 is the required rate of return)
= $35

Now calculating the present value of all the dividends = 2.60 / 1.10 + 2.99 / (1.10)² + 35 / (1.10)²
= 2.3636 +2.47107 + 28.9256
= $33.76

The intrinsic value of the stock would be $33.76

Note: No intermediate rounding is done