Question

Find the intrinsic value of the stock that pays a dividend of $3.24 and has a growth rate of 11.3% for 4 years then it stabilizes at a long-run growth rate of 3.2%. The stock has a Beta of .87, the risk free rate is 1.75 % and the market return is 9.65%.

Please show all the work, I have gone over it multiple times and i need to see where i am the getting correct.

Answer 1

Based on the given data, first the Cost of Equity is calculated; Cost of Equity is calculated based on the given data on the Market Return, Risk Free rate and Beta Factor; By subtracting Risk Free Return from Market Return, we will get the Risk Premium; This is required for assessing the Cost of Equity of this Company; Cost of Equity is computed as Risk Free Rate + (Risk Premium * Beta Factor); This beta factor is the risk factor associated with this company and hence the same is multiplied to the Risk Premium.

Once the Cost of Equity is derived, the same can be used as a discounting factor for calculating Present value of dividend flows forecast.

Based on the given forecast of dividend, the same is forecasted at 11.3% growth for next four years and further at 3.2% perpetually. pls remember this growth factor of 3.2% is a perpetual growth; By applying the discounting facotr (Cost of equity), these dividends (till Year 4) are discounted to the present value.

Once the dividends till year 4 are discounted, as a next step, need to find the Present value of the Terminal Dividend flow;

To arrive at the Terminal Value based on the dividend flows with perpertual Growth, the formula is given below: Terminal Dividend / (Cost of Equity - Perpetual Growth %); Once this terminal value is arrived, the same is discounted to the Present value using the discounting factor just immediate to the Terminal ; Hence Year 4 is considered; Now, with PV of values till Year 4 and PV of Terminal Value is there, the total of these two is considered as the Intrinsic Share value.

(in $) Year 0 Year 1 Year 2 Year 3 Year 4 Terminal 3.24 5.13 3.20% Dividend Growth % Discounting Factor Discounted Dividend 3.61 11.30% 0.9206 3.32 4.01 11.30% 0.8475 3.40 4.47 11.30% 0.7803 3.49 4.97 11.30% 0.7183 3.57 1.0000 CALCULATION OF SHARE VALUE Particulars PV of Year 1 to Year 4 (1) Cost of Equity Terminal Growth Terminal Value Present Value of terminal value (2) SHARE VALUE (1) + (2) 10.21 8.62% 3.20% 94.62 (Terminal Dividend/ (Cost of Equity - Terminal Growth) 67.96 Terminal Value * Year 4 discounting Factor 78.17 Market Return (a) Risk Free Rate (b) Beta Risk Premium (a) - (b) 9.65% 1.75% 0.87 7.90% 8.62% Cost of Equity Risk Free Rate + (Beta * Risk Premium)