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)
| 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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