Question

2. Your client is planning to purchase a stock that doesn't pay dividend in the next two years. In
the third year the stock will pay a dividend of Rs 10.This dividend will grow at 50% per annum for
the next three years. From then onwards the perpetual growth rate will stabilize to -1.00 %(minus
one percent) per annum. At 10% cost of equity of what will be the intrinsic value of this stock.

Please show step-wise calculations with formulas used.

Answer 1

Value of the stock today is the PV of the expected dividends
when discounted at the required rate of return of 8.6%.
Year	Dividend	PVIF at 10%	PV at 10%
1	$                         -	0.90909	$            -
2	$                         -	0.82645	$            -
3	$                  10.00	0.75131	$           7.51
4	$                  15.00	0.68301	$        10.25
5	$                  22.50	0.62092	$        13.97
6	$                  33.75	0.56447	$        19.05
Sum of PV of dividends of years 1 to 6		$        50.78
Continuing value of dividends at t6 = 33.75*(1-1%)/(0.1+0.01) =				$       303.75
PV of continuing value = 303.75*0.56477 =		$      171.46
Intrinsic value of the stock today = 50.78+171.46 =	$        37.27