Question

Problem 18-20

The Duo Growth Company just paid a dividend of $1.00 per share. The dividend is expected to grow at a rate of 23% per year for the next three years and then to level off to 5% per year forever. You think the appropriate market capitalization rate is 18% per year.

a. What is your estimate of the intrinsic value of a share of the stock? (Use intermediate calculations rounded to 4 decimal places. Round your answer to 2 decimal places.)

b. If the market price of a share is equal to this intrinsic value, what is the expected dividend yield? (Use intermediate values rounded to 2 decimal places. Round your answer to 2 decimal places.)

c. What do you expect its price to be one year from now? (Use intermediate values rounded to 4 decimal places. Round your answer to 2 decimal places.)

d-1. What is the implied capital gain? (Use intermediate values rounded to 2 decimal places. Round your answer to 1 decimal place.)

d-2. Is the implied capital gain consistent with your estimate of the dividend yield and the market capitalization rate?

• Yes

Answer 1

Solution

a. Intrinsic Value of a share is the current value of share in the market.

Current value of share is equal to present values of cash inflows to be received over the years.

Here in the question the dividend grows at the rate of 23% for 3 years and after that there is growth of 5% per year forever. So, the value of share will be calculated as per variable growth rate model.