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In: Finance

Your research on Skyway Corp. indicates that the company will be paying dividends of $1.75 per...

Your research on Skyway Corp. indicates that the company will be paying dividends of $1.75 per share in 2021, $1.95 per share in 2022, $2.25 per share in 2023 and $2.65 per share in 2024. You are given an estimate that the stock price in 2024 will be worth $37.50 per share. If your required annual return for all investments is 12%, what is the most you are willing to pay for Skyway stock today?

Explain what the answer means please.

Solutions

Expert Solution

The dividends are 1.75, 1.95, 2.25 and 2.65 from 2021 to 2024

The terminal value of the stock is 37.5 in 2024

the cost of capital is 12%

The present value factor @ 12% are calculated in the table below

The cash flows(ie the dividends and terminal value ) are multiplied with the present value and added to obtain the intrinsic value of the stock at present

Year Cash Flow(CF) PV factor CF* Pv factor
2021 1.75 0.892857143 1.5625
2022 1.95 0.797193878 1.554528061
2023 2.25 0.711780248 1.601505558
2024 2.65 0.635518078 1.684122908
2024 37.5 0.635518078 23.83192794
Total 30.23458447

So the most you are willing to pay for Skyway stock today is 30.23458447 $

The answer means that the intrinsic value of the stock today or the fair value of the stock today is 30.23. To obtain the intrinsic value the researcher needs to forecast the cash flows and discount them to present value and add them. So the stock today should trade at the intrinsic value. If it trades below the intrinsic price, the stock is undervalued and if it trades over the intrinsic price, it is overvalued

jeff jeffy answered 2 years ago
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