Question #250845

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.

Expert's answer

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}\u00d7" DF3

"=\\frac{12.75}{(0.1-0.03)}\u00d70.751315"

"=" $136.85

Growth rate"=" ROE"\u00d7" retention rate"=" 20%"\u00d7" 15%"=" 3%

Current value of stock"=" Present Value of dividends

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

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