Question

You estimate that a stock's dividend will grow at a rate of 12% for two years and then slow to 3% forever and ever and ever and ever... You require a 12% rate of return and the current dividend is $2 per share. What is the intrinsic value of the stock?

$26.89

** that is the answer my professor provided, I have not been able to come up with the same**

Answer 1

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

Future cash flows are dividends and expected value of share

Dividend for year 1

= Current dividend x (1 + Growth)

= $2 x 1.12

= $2.24

Similarly, D2

= $2.24 x 1.12

= $2.51

Expected stock price at the end of year 2

= Expected dividend for year 3 / (Re – G)

= $2.51 x 1.03 / (0.12 – 0.03)

= $28.71

Present value factor

= 1 / (1 + Re) ^ n

So, PV Factor for year 2 will be

= 1 / (1.12^2)

= 1 / 1.2544

= 0.797194

The following table shows the calculations:

Calculations	A	B	C = A x B
Year	Cash Flow	PV Factor	Present Values
1	2.24	0.892857	2
2	2.51	0.797194	2
2	28.71	0.797194	22.88889
		Price	26.89

So, as per above calculations, the stock price is $26.89