Question

Warf Co. just paid a dividend of $4.00 per share. The company will increase its dividend by
20 percent next year and will then reduce its dividend growth rate by 5 percentage points per
year until it reaches the industry average of 5 percent, after which the company will keep a
constant growth rate, forever. If the required return on Warf stock is 13 percent.
Required:
a) what will a share of stock sell for today?
b) What conditions must hold if a stock is to be evaluated using the constant growth model?
(2 mark)
c) Why the stock’s intrinsic value differs from the stock’s current market price? Explain (2
marks)

Answer 1

a) We can calculate the value of of stock today as follows:

Formulas used in the excel sheet are

So,the price of stock comes out to be $ 68.01.

b) The condition that must hold if a stock is to be evaluated using the constant growth model is as below

i) In order that the dividends grow at constant rate, the earnings of the company should also grow at the same rate.

c) Stock's Intrinsic value is the actual true value of the company as per the total assets and liabilities of the company, but the market value of the stock reflects the current value of the company as per the current share price. Therefore the stock’s intrinsic value differs from the stock’s current market price

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