In: Finance
Smirnoff & Co is facing a rapid growth in earnings and dividends. Management projects that dividends will grow at a rate of 12% during year 1, 10% during year 2, and 8% during year 3.
After that growth slows down to a normal rate of 5%. Company's required return is 9%. Last dividend paid (Do) was $3.50 per share.
Find: a. Horizon stock price;
b. Intrinsic stock value today.
c. Is the stock overpriced or underpriced if the market price today is $20 per share? Will an analyst issue a Buy or a Sell signal to the clients?
Required rate= | 9.00% | ||||||
Year | Previous year dividend | Dividend growth rate | Dividend current year | a. Horizon value | Total Value | Discount factor | Discounted value |
1 | 3.5 | 12.00% | 3.92 | 3.92 | 1.09 | 3.5963 | |
2 | 3.92 | 10.00% | 4.312 | 4.312 | 1.1881 | 3.62932 | |
3 | 4.312 | 8.00% | 4.65696 | a. 122.245 | 126.90196 | 1.295029 | 97.9916 |
Long term growth rate (given)= | 5.00% | b. Value of Stock = | Sum of discounted value = | 105.22 |
Where | |||
Current dividend =Previous year dividend*(1+growth rate)^corresponding year | |||
Total value = Dividend + horizon value (only for last year) | |||
Horizon value = Dividend Current year 3 *(1+long term growth rate)/( Required rate-long term growth rate) | |||
Discount factor=(1+ Required rate)^corresponding period | |||
Discounted value=total value/discount factor |
CMP at 20 is underpriced, analyst should issue a buy