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InterTune, Inc., just paid a dividend of $3.00 per share. You expect the dividend to increase...

InterTune, Inc., just paid a dividend of $3.00 per share. You expect the dividend to increase by 15% next year, 10% the following two years, and then 4% indefinitely thereafter. If you require a rate of return of 10%, what is the most you should be willing to pay for a share of InterTune stock?

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Expert Solution

Under the dividend discount model, the price which an investor is willing to pay for the share is the present value of future dividends expected from that share discounted at investors expected rate of return (in the given case - 10%)

The future dividends based on growth rates given are captured, after the 4th year the dividend is perpetually expected to grow at 4% hence using the PV of growing perpetuity formula (Dividend/Discount rate- Growth rate) the PV as of 4th year is arrived and then yearly dividends are discounted at Investors expected rate (10%) to arrive at stock price. Below table summarizes the same

Thus the price for Intertune stock which the investor willing to be paid would be $ 58.83 (all calculations rounded to two decimals)

jeff jeffy answered 8 months ago
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