Question

In: Finance

Nut and Bolt Guy, Inc., will pay a $1.10 dividend next year. This dividend is expected...

Nut and Bolt Guy, Inc., will pay a $1.10 dividend next year. This dividend is expected to grow by 6% percent for years 2 and 3. Following this, the firm expects the dividend by 3% in perpetuity. The firms cost of equity is 10%

Given this information, what is the intrinsic value of the stock?

A)$24.0

B)$33.8

C)$26.8

D)$ 3.75

Expert Solution

Dividend per share for the next 3 years

Dividend in Year 1 (D1) = $1.10

Dividend in Year 2 (D2) = $1.1660 [$1.10 x 106%]

Dividend in Year 3 (D3) = $1.2360 [$1.1660 x 106%]

Stock Price for the Year 3 (P3)

Stock Price for the Year 3 = D3(1 + g) / (Ke – g)

= $1.2360(1 + 0.03) / (0.10 – 0.03)

= $1.2730 / 0.07

= $18.19

Current price of the common stock

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 3

Year	Cash flow ($)	Present Value Factor (PVF) at 10.00%	Present Value of cash flows ($) [Cash flows x PVF]

1	1.1000	0.90909	1.00
2	1.1660	0.82645	0.96
3	1.2360	0.75131	0.93
3	18.19	0.75131	13.66

TOTAL	16.56

Hence, the Intrinsic value of the stock will be $16.56

But the answer is not listed in the given answer choices

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 2 years ago

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