Question

Stella Corporation just paid a $3.00 dividend this morning. Analysts believe that the company's dividends will grow 30% per year for each of the next 2 years. after the second year, analysts believe that dividends will grow constantly into the foreseeable future at 4% per year. if analysts believe that Stella Corporation stock should earn a required return of 12% per year, what is the intrinsic value of a share its stock today?

Answer #1

g1 = growth rate = 30%

g2 = growth rate = 4%

r = required return = 12%

D0 = Current Dividend = $3.00

D1 = Dividend in Year 1 = D0 *(1+g1) = $3.00*(1+30%) = $3.90

D2 = Dividend in Year 2 = D1 * (1+g1) = $3.90 * (1+30%) = $5.07

D3 = Dividend in Year 3 = D2 * (1+g2) = $5.07 * (1+4%) = $5.2728

Horizon Value = D3/ (r - g2)

= $5.2728 / (12%-4%)

= $65.91

Value of stock today = [D1 / (1+r)^1] + [D2 / (1+r)^2] + [Horizon Value / (1+r)^2]

= [$3.90 /(1+12%)^1] + [$5.07 / (1+12%)^2] + [$65.91 / (1+12%)^2]

= [$3.90 /1.12] + [$5.07 / 1.2544] + [$65.91 / 1.2544]

= $3.482142857 + $4.041772959 + $52.54304847

= $60.06696429

Therefore, Intrinsic Value of stock today is $60.07

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