Question

First Innovators, Inc. (FII) is presently enjoying relatively high growth because its latest new product is years ahead of its competition. Management expects earnings and dividends to grow at a rate of 40% for the next 4 years, after which its new product’s competition will increase and reduce the growth rate in earnings and dividends to 2%, i.e., g = 2%. The company’s last dividend, D0, was $2.75. FII’s beta is 1.50, the market risk premium is 6.25%, and the risk-free rate is 3.50%. What is the intrinsic value of FII’s common stock? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.

Answer 1

Required return=risk free rate+Beta*market risk premium

=3.5+(1.5*6.25)=12.875%

D1=(2.75*1.4)=3.85

D2=(3.85*1.4)=5.39

D3=(5.39*1.4)=7.546

D4=(7.546*1.4)=10.5644

Value after year 4=(D4*Growth rate)/(Required return-Growth rate)

=(10.5644*1.02)/(0.12875-0.02)

=99.0867862

Hence intrinsic value=Future dividend and value*Present value of discounting factor(rate%,time period)

=3.85/1.12875+5.39/1.12875^2+7.546/1.12875^3+10.5644/1.12875^4+99.0867862/1.12875^4

=80.44(Approx).