Question

Computer stocks currently provide an expected rate of return of 15%. MBI, a large computer company, will pay a year-end dividend of $2.5 per share. (a) If the stock has an intrinsic value of $50 per share, what must be the market's expectation of the growth rate of MBI dividends? Use the constant growth model. (b) Based on the constant growth model, what is the intrinsic value of MBI in three years (V3)? (c) Suppose the dividend growth forecasts for MBI will decrease to 6% per year in three years from today (t3), what will happen to the intrinsic value of MBI stock? (HINT: You will have to use the multistage growth model. can someone help me compute without using excel?

Answer 1

a). r = [D1/P0] + g

g = r - [D1/P0]

= 0.15 - [$2.5/$50]

= 0.15 - 0.05 = 0.10, or 10%

b). V3 = V0 * (1 + g)³ = $50 * (1 + 0.10)³ = $50 * 1.331 = $66.55

c). D1 = $2.5

D2 = $2.5*(1 + 0.10) = $2.75

D3 = D2 * (1 + gC) = $2.75 * (1 + 0.06) = $2.915

P2 = D3 / (r - gC) = $2.915 / (0.15 - 0.06) = $2.915 / 0.09 = $32.39

P0 = [D1/(1+r)] + [(D2+P2)/(1+r)²]

= [$2.75/(1+0.15)] + [($2.915+$32.39)/(1+0.15)²]

= $2.39 + $26.69 = $29.09