A company’s common stock is expected to pay $2 in dividends annually over the next four...

A company’s common stock is expected to pay $2 in dividends annually over the next four years. At the end of the fourth year, its stock is expected to be valued at $45. If the firms cost of equity is 12%, what is its intrinsic value? What should its stock sell for in 1 year?

Please use excel and show work.

Expert Solution

As per dividend discount model, current share price is the present value of future dividends.

a)	Intrinsic value	$ 34.67

Working:

	Step-1:Present value of next 4 years dividend

	Present value	=	Annual dividend	*	Present value of annuity of 1
		=	$ 2.00	*	3.037349
		=	$ 6.07

	Working:

	Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
		=	(1-(1+0.12)^-4)/0.12		i	=	12%
		=	3.037349		n	=	4

	Step-2:Present value of dividend after 4 years

	Present value	=	Price of stock 4 years from now	*	Discount factor
		=	$ 45.00	*	0.635518
		=	$ 28.60

	Working:

	Discount factor	=	(1+i)^-n
		=	(1+0.12)^-4
		=	0.635518

	Step-3:Price of stock now

	Price of stock now	=	$ 6.07	+	$ 28.60
		=	$ 34.67

b)	Intrinsic value in 1 year	$ 36.83

Working:

	Step-1:Present value of next 3 years dividend

	Present value	=	Annual dividend	*	Present value of annuity of 1
		=	$ 2.00	*	2.401831
		=	$ 4.80

	Working:

	Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
		=	(1-(1+0.12)^-3)/0.12		i	=	12%
		=	2.401831		n	=	3

	Step-2:Present value of dividend after 4 years

	Present value	=	Price of stock 4 years from now	*	Discount factor
		=	$ 45.00	*	0.71178
		=	$ 32.03

	Working:

	Discount factor	=	(1+i)^-n
		=	(1+0.12)^-3
		=	0.71178

	Step-3:Price of stock now

	Price of stock now	=	$ 4.80	+	$ 32.03
		=	$ 36.83

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