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A company’s common stock is expected to pay $2 in dividends annually over the next four...

A company’s common stock is expected to pay $2 in dividends annually over the next four years. At the end of the fourth year, its stock is expected to be valued at $45. (5 pts) If the firm’s cost of equity is 12%, what is its intrinsic value today? (5 pts) What should its stock sell for in 1 year?

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Answer #1

Intrinsic value is basically the PV of the dividends of company, discounted at the Cost of Equity.

When we say stock is valued at $45 at the end of year 4, it means, $45 is the PV of all dividends expected from Year 5 till infinity.

D1 = $2

D2 = $2

D3 = $2

D4 = $2. To this add $45 as well, which is the PV (at t=4) of future value of dividends.

Intrinsic Value of stock today = 1.7857 + 1.5944 + 1.4236 + 1.2710 + 28.5983 = $34.67

Intrinsic value of stock in Year 1 =

Intrinsic value of stock after year 1 = 1.7857 + 1.5944 + 1.4236 + 32.0301 = $36.83

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