Question

Phoenix industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another two years (the dividend in year 2 will be $2 and the dividend in year 3 will be $3). After the third year (in which dividends are $3 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 6%. Assume that the firm’s investors expect to earn a return of 14% on this stock.

What is the terminal price of the Phoenix industries at the end of year 3, that is, what is P3 ?

What is the intrinsic value of the Phoenix industries’ stock, that is, what is P0 ?

If the current price of the stock in the market is $18 per share, the Phoenix industries’ stock is (compared to its intrinsic value)

Answer #1

Required rate= | 14.00% | ||||||

Year | Previous year dividend | Dividend growth rate | Dividend current year |
Terminal value |
Total Value | Discount factor | Discounted value |

1 | 0 | 0.00% | 1 | 1 | 1.14 | 0.8772 | |

2 | 1 | 0.00% | 2 | 2 | 1.2996 | 1.53894 | |

3 | 2 | 0.00% | 3 |
39.75 |
42.75 | 1.481544 | 28.85503 |

Long term growth rate (given)= | 6.00% |
Intrinsic value= |
Sum of discounted value = |
31.27 |

Where | |||

Total value = Dividend + Terminal value (only for last year) | |||

Horizon value = Dividend Current year 3 *(1+long term growth rate)/( Required rate-long term growth rate) | |||

Discount factor=(1+ Required rate)^corresponding period | |||

Discounted value=total value/discount factor |

Market price is underpriced compared to intrinsic value

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