Question

Problem 8-20
Nonconstant Growth Stock Valuation

Reizenstein Technologies (RT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, RT is expected to experience a 19% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and RT's growth rate will slow to 8% per year indefinitely. Stockholders require a return of 11% on RT's stock. The most recent annual dividend (D₀), which was paid yesterday, was $1.95 per share.

1. Calculate RT's expected dividends for t = 1, t = 2, t = 3, t = 4, and t = 5. Round your answers to the nearest cent. Do not round intermediate calculations.
   D₁ = $  
   D₂ = $  
   D₃ = $  
   D₄ = $  
   D₅ = $  
   
2. Calculate the estimated intrinsic value of the stock today, . Proceed by finding the present value of the dividends expected at t = 1, t = 2, t = 3, t = 4, and t = 5 plus the present value of the stock price that should exist at t = 5, . The  stock price can be found by using the constant growth equation. Note that to find  you use the dividend expected at t = 6, which is 8% greater than the t = 5 dividend. Round your answer to the nearest cent. Do not round your intermediate computations.
   $  
   
3. Calculate the expected dividend yield (D₁/), the capital gains yield expected during the first year, and the expected total return (dividend yield plus capital gains yield) during the first year. (Assume that  = P₀, and recognize that the capital gains yield is equal to the total return minus the dividend yield.). Round your answers to two decimal places. Do not round your intermediate computations.

   Expected dividend yield	%
   Capital gains yield	%
   Expected total return	%

   
   Also calculate these same three yields for t = 5 (e.g., D₆/). Round your answers to two decimal places. Do not round your intermediate computations.

   Expected dividend yield	%
   Capital gains yield	%
   Expected total return	%

Answer 1

Answer : 1) Calculation of RT's Expected Dividend :

D1 = D0 * (1 + growth rate)

= 1.95 * (1 + 0.19)

= 2.3205 or 2.32

D2 = D1 * (1 + growth rate)

= 2.3205 * (1 + 0.19)

= 2.761395 or 2.76

D3 = D2 * (1 + growth rate)

= 2.761395 * (1 + 0.19)

= 3.28606005 or 3.29

D4 = D3 * (1 + growth rate)

= 3.28606005 * (1 + 0.19)

= 3.9104114595 or 3.91

D5 = D4 * (1 + growth rate)

= 3.9104114595 * (1 + 0.19)

= 4.65

(b.) Calculation of Intrinsic Value :

Intrinsic Value is shown in the table below :

Year	Dividend	PVF @11%	Present Value of Dividend
0	1.95
1	2.3205	0.900900901	2.090540541
2	2.761395	0.811622433	2.241210129
3	3.28606005	0.731191381	2.402738787
4	3.91041146	0.658730974	2.57590915
5	4.65338964	0.593451328	2.76156026
5	167.522027	0.593451328	99.41616936
		Intrinsic Value	111.4881282 or 111.49

Price at year 5 = 4.65338964 * (1 + 0.08) / (0.11 - 0.08)

= 167.52

(iii.) Expected Total Return = 11%

Expected Dividend Yield = D1 / P0

= 2.3205 / 111.49

= 2.08%

Capital Gain Yield = 11% - 2.08% = 8.92%

(iv.) Expected Dividend Yield = D6 / P5

= 5.0256608112 / 167.52

= 3%

Expected Total Yield = 11%

Capital Gain Yield = 11% - 3% = 8%