Question

Your task is to find the value of a company stock. You have the following information: a) Investors expect 10 EUR dividend next week. Buying stock today entitles you to receive that dividend b) Dividends are expected to stay constant for the next three years. c) However, dividends are expected to start growing 3% a year starting from year 4. d) Expected return from investments with comparable risk is 13%. Question: 1. Based on information above, what is the fundamentally justified price of a stock? 2. You observe that the current market price is 95 EUR. What should be your investment strategy given your calculations above. Even if you were not able to estimate the price, you can still describe your course of action

Answer 1

Question 1 ) Price of stock

Year	Event	Cash flow	Discounting Facctor@13%	Present Value
0	Dividend	10	1	10
1	Dividend	10	0.885	8.85
2	Dividend	10	0.783	7.83
3	Dividend	10	0.693	6.93
3	Price	103	0.693	71.38
				EUR 105

Calculation of share price in year 3

Price = Dividend for year 4 / ( Expected Return - growth )

=(10+3% ) / ( 13%-3% )

= 10.3 / 10%

= 103

Question 2 ) Investment Strategy

Current market price of the stock is EUR 95 which is less than the value of stock calculated above ( EUR 105 ).

Therefore the share is underpriced.

Therfore we should buy the stock.