Question

The National Financing Company paid $2.00 per share in common stock

dividends last year. The company’s policy is to allow its dividend to grow

at g₁=10 percent for 4 years and then the rate of growth changes to g₂=3 percent per year from year five and on. What is the fair value of the stock if the required rate of return is 8 percent? Would you buy this stock if the market price is $55.2?

Answer 1

Price of Stock = PV of Cfs from it.

Div Calculation:

Year	CF	Formula	Calculation
1	$      2.20	D0(1+g)	2*1.1
2	$      2.42	D1(1+g)	2.2*1.1
3	$      2.66	D2(1+g)	2.42*1.1
4	$      2.93	D3(1+g)	2.66*1.1
5	$      3.02	D4(1+g)	2.93*1.03

P4 = D5/ [ Ke - g ]

= 3.02 / [ 8% - 3% ]

= $ 3.02 / 5%

= $ 60.40

P0:

Year	CF	PVF @8%	Disc CF
1	$      2.20	0.925926	$      2.04
2	$      2.42	0.857339	$      2.07
3	$      2.66	0.793832	$      2.11
4	$      2.93	0.73503	$      2.15
4	$   60.40	0.73503	$   44.40
Price of Stock			$   52.77

If it is available @ 55.2, it is overpriced. Not adviced to buy.