Question

Melissa Popp is thinking about buying some shares of R.H. Lawncare​ Equipment, at $ 40.88 per share. She expects the price of the stock to rise to $57.32 over the next 3 years. During that time she also expects to receive annual dividends of $4.38 per share.

a. What is the intrinsic worth of this​ stock, given a required rate of return of 11%​?

b. What is its expected​ return?

THIS QUESTION IS POSTED AS IS, MORE SO HOW DOES SHE KNOW THE STOCK IS GOING TO RAISE TO $57.32, ALSO, (I used Excel for this and it is giving me an error probably I am doing something wrong). PLEASE USE EXCEL AND ALSO A CALCULATOR WHEN SOLVING THIS QUESTION AND BE SPECIFIC WITH THE STEPS.

THANK YOU

Answer 1

Before starting the solution, expectation of 57.32 after 3 years is just her expectation. She might have used any model or some technical analysis to come to that figure. Anyways, since the question has already mentioned value after 3 years, we should not get into this right now as that is not the learning objective of this topic.

A. Intrinsic Value

Using Excel.

We discount the future cashflows at 11% to find the intrinsic value. We use a discount factor for each year and multiply that by Cashflows .

We sum the present values to get the intrinsic value.

DF for each year = 1/(1+R)^N i.e forr year 1 = 1/(1+11%)^1

		11%
	Cashflows	DF	PV
1	4.38	0.900901	3.945946
2	4.38	0.811622	3.554906
3	4.38	0.731191	3.202618
3	57.32	0.731191	41.91189
			52.61536

We get Intrinsic Value of 52.61536

Using Financial Calculator:

We feed follwoing :

I/Y interest rate = 11%

N No of years = 3

PMT Dividend per year = 4.38

FV = End value of shares = 57.32

Calculate PV we get 52.62

B. What is the return of the shares.

Using Excel. We use goal seek function such that Total of present value is 40.88 and interest rate is variable.

In goal seek function, we select the cell where we have sum up the present value and set to value = 40.88, by changing cell where we have selected the interest rate  We get interest rat of 21.60%

Using Fin Calc:

Now we feed PV Present Value as -40.88 as that is our outflow.

Keeping N, PMT and FV same as above.

Then we calculate I/Y interest Rate we get 21.60%