Answer to Question #250845 in Finance for Sanchi

Question

A company pays following dividends: D1 (dividend in year 1/next year) is $7, D2(dividend in year 2) is $8, D3(dividend in year 3) is $12.38. Thereafter, the dividend will grow at a constant rate. SupposeROE will be 20% with dividend and EPS will being $12.75 and $15 in year 4 respectively. The required rate of return is 10%, use 2-stage DDM to estimate the intrinsic value of stock at the current year.

Answer 1

Dividend of non constant growth stage

Discount factors

$=1.10^{-1}=0.909091$

$=1.10^{-2}=0.826446$

$=1.10^{-3}=0.751315$

Dividend for year 1$=$ $7.00

Discount factor$=$ 0.909091

Present value$=$ $ 6.36

Dividend year 2 $=$ 8.00

Discount factor$=$ 0.826446

Present value$=$ $ 6.61

Dividend for year 3$=$ $12.38

Discount factor$=$ 0.751315

Present value$=$ $ 9.30

Total present value $=$ $22.28

Present value of dividend of constant growth stage.

Dividend of year 4$=$ $12.75(Given in the question)

Growth rate$=$ 3%

Required Return$=$ 10%

Discount Factor of year 3$=$ 0.751315

Present value $=$ $\frac{D4}{Ke-g}×$ DF3

$=\frac{12.75}{(0.1-0.03)}×0.751315$

$=$ $136.85

Growth rate$=$ ROE$×$ retention rate$=$ 20%$×$ 15%$=$ 3%

Current value of stock$=$ Present Value of dividends

Value of stock$=$ $22.28$+$ $136.85$=$ $159.12