Question

Determine the price of a share of stock whose last annual dividend payment was $1.5 assuming a required rate of return of 15% and considering the following restrictions: a) The dividend payment is expected to remain constant indefinitely. b) The dividend payment is expected to grow at a constant rate of 3% per year indefinitely. c) The dividend payment is expected to grow at a rate of 7% for four years and then immediately decline to 3% indefinitely. d) How does the calculated intrinsic values compare to the current price of $14? BONUS: Use an IF statement to display whether the stock is undervalued, overvalued, or fairly valued. Millennium Inc. stock is selling for $20 a share based on a 15 percent rate of return. What is the last annual dividend payment if the dividends are expected to grow at 3% annually?

Answer 1

Solution 1:

a. Given that Dividend payment, = $1.5, Required rate of return, = 15%

The price of share of stock, is given by:-

P = $1.5/0.15

P = $10

b. Given that Dividend payment, = $1.5, Required rate of return, = 15%, growth rate, = 3%

The price of share of stock, is given by:-

P = $12.875

c. Given that Dividend Given that Dividend payment, = $1.5, Required rate of return, = 15%, constant growth rate, = 3%, Growth rate, = 7%

P = 1.396 + 1.299 + $1.208 + $1.124 + $9.649

P = $14.68

d. In part a, the stock price is $10 which is less than $14, therefore it is overvalued.

In part b, the stock price is $12.875 which is less than $14, therefore it is overvalued.

In part c, the stock price is $14.68 which is greater than $14, therefore it is undervalued.  

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Solution 2:

Given that Stock price, = $20, Required return, = 15% and Growth rate, = 3%

Using constant growth model, we have

Hence, the last annual dividend payment is $2.33.