Question

1. McCormick & Company is considering buying a new factory in Largo, Maryland. The company is considering issuing additional common stock to finance the purchase of the factory. McCormick & Company stock has recently paid a dividend payment of $0.52 per share. Dividends are expected to grow by 8.5 percent per year for the next five years. The required return on the stock is 12 percent. Determine the intrinsic value of the stock, also known as today's stock price.

Answer 1

Let the dividends in year n be denoted by Dn

Given, D0 = 0.52

Growth in dividend = g = 8.5%

Hence, D1 = 0.52(1+0.085)
D2 = 0.52(1+0.085)²
D3 = 0.52(1+0.085)³
D4 = 0.52(1+0.085)⁴
D5 = 0.52(1+0.085)⁵

The dividends remain constant after this period

Required return = r = 12%

Hence, P4 = D5/r = 0.52(1+0.085)⁵/0.12

Intrinsic value of stock = P0 = D1/(1+r) + D2/(1+r)² + D3/(1+r)³ + D4/(1+r)⁴ + P4/(1+r)⁴

= 0.52(1+0.085)/(1+0.12) + 0.52(1+0.085)²/(1+0.12)² + 0.52(1+0.085)³/(1+0.12)³ + 0.52(1+0.085)⁴/(1+0.12)⁴ + (0.52(1+0.085)⁵/0.12)/(1+0.12)⁴

= $6.06