Question

Last year, Buch Gmbh, a German firm, paid a dividend of EUR 3,30 per year. The current stock price of the firm is EUR 194,98. An analyst documents that the current required return on equity for the firm is 9 percent and dividends are expected to grow at 14 percent for the next two years, 12 percent for the following five years, and 6,75 percent thereafter. Evaluate the firm's current stock price!

Answer 1

Value of stock price=(D1/(1+9%))+(D2/(1+9%)^2)+(D3/(1+9%)^3)+(D4/(1+9%)^4)+(D5/(1+9%)^5)+(D6/(1+9%)^6)+(D7/(1+9%)^7)+((D8+Terminal Value)/(1+9%)^8)

for the first two years, it grown at 14%

D1=D0*(1+14%)=3.30*(1+14%)=3.762

D2=D1*(1+14%)=3.762*(1+14%)=4.289

And for the next five years grown at 12%

D3=D2*(1+12%)=4.289*1.12=4.803

D4=4.803*1.12=5.380

D5=5.380*1.12=6.025

D6=6.025*1.12=6.748

D7=6.748*1.12=7.558

Now growth at 6.75%

D8=7.558*(1+6.75%)=8.068

Terminal value at Year7=D8/(required retrun-growth rate)=8.068/(9%-6.75%)=358.591

Value of stock price=(3.762/(1.09))+(4.289/(1.09)^2)+(4.803/(1.09)^3)+(5.380/(1.09)^4)+(6.025/(1.09)^5)+(6.748/(1.09)^6)+((7.558+358.591)/(1.09)^7)

=3.45+3.61+3.71+3.81+3.92+4.02+200.30

=222.82

The intrinsic value of the Stock=EUR 222.82 where as the market price is EUR 194.98. Therefore it is undervalued and a good buy.