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?

Answer 1

a) Dividend next year = D1 = 1

Dividend after 2 year = =D2= D1 * ( 1+g) = 1 *1.50 = 1.5

dividend after 3 year = D3 = D2*1.5 = 1.5*1.5 = 2.25

b)

Dividend after 4 years = D4= D3 * ( 1 + constant growth rate ) = 2.25 * 1.06 = 2.385

Horizon value = D4 / ( Required rate of return - constant growth rate)

= 2.385 / ( 0.11 -0.06)

= 2.385 / 0.05 = $47.70

c)

Intrinsic value of the share = D1 / (1+r) + D2 / ( 1+r)^2 + D3 / ( 1 +r) ^3 + Horizon value / ( 1+r)^3

= 1/1.11 + 1.50/1.11^2 + 2.25/ 1.11^3 + 47.70 / 1.11^3

= 0.9009 + 1.2174 + 1.6452 + 34.8778

= $38.64