Question

Capri Inc. is expected to pay $1.98 dividend per share for each of the next 3 years, after which there are no additional dividend payments. Estimate its intrinsic value per common share using the dividend discount model assuming a cost of equity of 7%.

$26.32

$28.29

$5.20

$5.94

Answer 1

Solution :

The formula for calculating the Intrinsic value per common share using the Dividend Discount Model is

Current price of a share of stock = Present value of dividends from Year 1 to Year n + Present value of share of stock at year n

As per the information given in the question we have n = 3 years

Thus the Intrinsic value per common share = [ D1 * ( 1 / ( 1 + r)1 ) ] + [ D2 * ( 1 / ( 1 + r)2 ) ] + [ D3 * ( 1 / ( 1 + r)3 ) ] + [ P3* ( 1 / ( 1 + r)3 ) ]

As per the information given in the question we have

D1 = $ 1.98 ; D2 = $ 1.98 ; D3 = $ 1.98   ; r = 7.00 % = 0.0700

Calculation of price of share at year 3 :

The formula for calculating the price of the share at year 3

P3 = [ D3 *( 1 + g ) ] / ( Ke – g )

We know that

D3 = $ 1.98 ; g = 0 % = 0.00   ; Ke = 7 % = 0.07 ;

P3 = [ $ 1.98 * ( 1 + 0.00 ) ] / ( 0.07 – 0.00 )

= ( $ 1.98 * 1 ) / 0.07

= $ 1.98 / 0.07

= $ 28.285714

Thus the price of the share at year 3 = $ 28.285714

Applying the available information in the formula we have the price of a share of stock as follows :

= [ $ 1.98 * ( 1 / 1.07 )1 ] + [ $ 1.98 * ( 1 / 1.07 )2 ] + [ $ 1.98 * ( 1 / 1.07 )3 ] + [ $ 28.285714 * ( 1 / 1.07 )3 ]

= [ $ 1.98 * 0.934579 ] + [ $ 1.98 * 0.873439 ] + [ $ 1.98 * 0.816298 ] + [ $ 28.285714 * 0.816298 ]

= $ 1.850467 + $ 1.729409 + $ 1.616270 + $ 23.089569

= $ 28.285714

= $ 28.29 ( when rounded off to two decimal places )

Thus the Intrinsic value per common share is = $ 28.29

The solution is Option 2 = $ 28.29