Question

Digital Plc just paid a dividend of $3 per share. Analysts expect its dividend to grow at 12% per year for the next three years and then 6% per year, indefinitely thereafter. If the required rate of return on the stock is 10%, what is the current value of the stock?

a) 93 b) 87 c) 77 d) 69 e) 98

Answer 1

Correct Answer is a) 93

Intrinsic Value of Share as per Dividend Model = Present Value of all Future Dividends.

In this Question , it is 2 stage model, during the next 3years dividend is expected to grow at the rate 12% , and thereafter at 6% indefinitely.

Intrinsic Value of Share as per Dividend Model = Stage 1 + Stage 2

Stage 1 = Present Value of Dividends for next 3 Years

Stage 2 = Present Value of Dividends from Year 4 Onwards.

Present Value of Dividends for next 3 Years
Year	Dividend	Discount Rate @ 10%	Present Value
1	3.36	0.91	3.05
2	3.76	0.83	3.11
3	4.21	0.75	3.17
Total	9.33

Calculation of present Value of Dividends from Year 4 Onwards.

Intrinsic Value at the end of 3rd Year =[ D3 (1+g)] / [Re -g]

Were D3 is the dividend for 3rd Year

g is the growth rate from year 3 onwards ie 6%

Re is the required Rate of return ie 10%

Substiuting Values we get

IV3 = [4.21 (1.06)] / [0.1 -0.06]

IV3 = 111.565

Discounting IV3  @ the rate 10% to now is = 111.565 /(1.1)3

Stage 2 value = 83.82

Intrinsic Value of Share as per Dividend Model = Stage 1 + Stage 2

= 9.33+ 83.82

=93.25

So the Current value of Stock us $93.25 , Rounded to $93