Question

# Your broker offers to sell you some shares of Bahnsen & Co. common stock that paid...

a). D0 = 2.00; g = 8%

D1 = D0*(1+g)^1 = 2*(1+8%) = 2.16

D2 = 2*(1+8%)^2 = 2.33

D3 = 2*(1+8%)^3 = 2.52

b). Present Values (PV) with discount rate (d) of 10%:

PV(D1) = D1/(1+d)^1 = 2.16/(1+10%)^1 = 1.96

PV(D2) = D2/(1+d)^2 = 2.33/(1+10%)^2 = 1.93

PV(D3) = D3/(1+d)^3 = 2.52/(1+10%)^3 = 1.89

c). P3 = 136.05

PV(P3) = 136.05/(1+10%)^3 = 102.22

d). Total share price today = PV(D1) + PV(D2) + PV(D3) + PV(P3) = 1.96+1.93+1.89+102.22 = 108.00

This is the intrinsic value of the stock, as of today. One should not pay more than this for the stock.

e). Present value of the stock using a constant growth rate (g) of 8% and discount rate (k) of 10%:

Current share price = D1/(k-g) = 2.16/(10%-8%) = 108.00 (same as calculated in part d)

f). The holding period is not going to make any difference to the value of the stock because the present value captures all the future cash flows expected from the stock.

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