Question

Mr. Subhash also an individual investor who swears by equity and is sometimes swayed by market buzz. He invested in the stock of Dandiya Enterprises whose promoter is very close to the government. Dandiya paid a dividend of Rs 5/- just a while ago and the market buzz is the incumbent government will lose to the opposition party in the elections whose results are awaited. Because of the adverse government, Dandiya Enterprises will experience a negative growth rate of 8% P.A. in the forthcoming five years. In the subsequent years the stock will grow perpetually at a long-term growth rate of 15% per annum. If the required rate of return is 18% what will be the value of the stock with these changes.

Answer 1

Stock price will be the present value of all the dividend paid by the company starting from next year

current dividend D0=5

Next year dividend= D1=D0*(1+g) ---g=growth rate; here its negative

Present value of next year dividend =D0*(1+g)/(1+k) -----where k=18% is required rate of return

Present value of dividends from Year 1 to 5=

5*(1-8%)/(1+18%) +5*(1-8%)^2/(1+18%)^2+5*(1-8%)^3/(1+18%)^3+5*(1-8%)^4/(1+18%)^4 +5*(1-8%)^5/(1+18%)^5

=12.59

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After year 5; Dividends grow at a long term rate of 15% ----- g=15%

Present value of perpetuity at year 5 =value of dividend in year 6/(k-g)

=(5*(1-8%)^5)*(1+15%)/(.18-.15) =126.32

Present value of perpetuity in year 0= 126.32/(1+18%)^5 =55.21

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Total value of the stock at present =55.21+12.59 =67.8 Rs