Question

Paradise Tours, Inc. just paid a dividend of $5.95. Analysts expect the company's dividend to grow by 35% this year, by 20% in year 2, and at a constant rate of 6% in Year 3 and thereafter. The required rate of return on PTI's stock is 14.75%. What is the best estimate of the stock's current intrinsic value? Note: Enter your answer rounded off to two decimal points. Do not enter $ or comma in the answer box. For example, if your answer is $123.456 then enter as 123.46 in the answer box.   

Answer 1

Dividend just paid = $5.95
Growth rate Year 1 = 35%
Growth rate Year 2 = 20%
Growth rate in Year 3 and thereafter = 6%
Required rate of return = 14.75%.

Calculation of Stock's current intrinsic value

Po = PV of dividends during supernormal period + PV of Price of stock when growth rate is constant
Po = PV of dividends in year 1 & 2 + PV of Price of stock at the end of year 2

Year	Working	Amount	**PVF @14.75%	Present Value
1	D1 =5.95*(1+0.35)	$8.0325	0.87145969	$7.0000
2	D2 =5.95*(1+0.35)*(1+0.2)	$9.6390	0.75944200	$7.3203
2	P2 (note 1)	$116.7696	0.75944200	$88.6797
			Intrinsic Value	$103

Stock's current intrinsic value = $103

Note 1 : Calculation of Price of share at end of year 2  

P2 = D2(1+g) / (Ke - g)
where D2 = Dividend paid at end of yr 2
g = growth rate
ke = required rate of return
P2 = $9.6390(1+0.06)/(0.1475 - 0.06)
P2 = $116.7696

**PVF(r,t) = (1/(1+r))^n