Question

Flash Inc. was founded 5 years ago. It has been profitable for the last 2 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $1 dividend starting one year from today, then it will increase the dividend growth by 50% for the next two years, and then the company will achieve a long run growth rate of 6%. Assuming a required return of 11%, what is your estimate of the stock's intrinsic value today? a) Calculate the Flash Inc. non-constant dividends. b) Calculate the Flash Inc. horizon value. c) What is the firm's intrinsic value today, P̂ 0?

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Answer 1

a)

Dividend after 1 year = 1

Dividend after 2 year = 1 *1.5 = 1.5

Dividend after 3 years = 1.5*1.5 = 2.25
Dividend after 4 years = 2.25 * 1.06 = 2.385

Horizon value = Dividend for year 4 / ( required rate of return - growth rate)

= 2.385 / ( 0.11 - 0.06 ) = 2.385 / 0.05 = 47.70

Intrinsic value today = dividend for year 1 / ( 1+r) + dividend for year 2 / ( 1+r)^2 + dividend for year 3 / ( 1+r)^3 + horizon value / ( 1+r)^3

= 1 /1.11 + 1.5 /1.11^2 +2.25 /1.11^3 + 47.7 / 1.11^3

= 0.9009 + 1.2174 + 1.6452 + 34.8778

= 38.9961

Intrinsic value = $39.00