Question

Last year, Buch Gmbh, a German firm, paid a dividend of EUR 3,30 per year. The current stock price of the firm is EUR 194,98. An analyst documents that the current required return on equity for the firm is 9 percent and dividends are expected to grow at 14 percent for the next two years, 12 percent for the following five years, and 6,75 percent thereafter. Evaluate the firm's current stock price!

Answer 1

Here D0 = 3.30; P0 = 194.98. Keeping in mind the given growth rates the future dividends will be:

Year	Dividend		g
0	D0	3.30
1	D1	3.76	14%
2	D2	4.29	14%
3	D3	4.80	12%
4	D4	5.38	12%
5	D5	6.03	12%
6	D6	6.75	12%
7	D7	7.56	12%
8	D8	8.07	6.75%

Now P8 = D8*(1+g)/(r-g) = 8.07*1.0675/(0.0.09 - 0.0675) = 382.80

Thus firm's fair stock price = present value of all future dividends + present value of P8 i.e. present value of D1 to D8 + present value of P8.

Year	Dividend		g	1+r	PVIF	PV
0	D0	3.30		1.09	1.0000
1	D1	3.76	14%		0.9174	3.45
2	D2	4.29	14%		0.8417	3.61
3	D3	4.80	12%		0.7722	3.71
4	D4	5.38	12%		0.7084	3.81
5	D5	6.03	12%		0.6499	3.92
6	D6	6.75	12%		0.5963	4.02
7	D7	7.56	12%		0.5470	4.13
8	D8	8.07	6.75%		0.5019	4.05
8	P8	382.80			0.5019	192.11
					Total	222.82

Thus fair value of the stock is $222.82. This is more than the current stock price of 194.98. Thus we can say that the stock is undervalued and hence I will buy this stock.