Question

Question 4 Flash Inc. was founded 5 years ago. It has been profitable for the last 2 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $1 dividend starting from today, then it will increase the dividend growth by 50% for the next two years, and then the company will achieve a long run growth rate of 7.5%. Assuming a required return of 12%, what is your estimate of the stock's intrinsic value today?

a) Calculate the Flash Inc. non-constant dividends.

b) Calculate the Flash Inc. horizon value.

c) What is the firm's intrinsic value today, P̂ 0?

Mention the appropriate BA II Plus keys (where required).

Answer 1

a) Calculate the Flash Inc. non-constant dividends.

Non constant dividends Now = $1; Year 1 = $1.50; Year 2 = $2.25

b) Calculate the Flash Inc. horizon value.

Horizon value of Dividend = $53.75

c) What is the firm's intrinsic value today, P̂ 0?

Intrinsic value = $46.98

Note:

1. Horizon value of Dividend equals Divided in year 3 /( required rate of return - long term growth rate)

2. Intrinsic value equals the present value of all future dividends discounted at required rate of return

Workings: