Question

Q7. General Electric Corp. (GE) paid cash dividends totaling $0.57 per share in 2000. Over the previous three years, GE's dividends grew at an annual rate of 15.4 per-cent. Assume that this growth rate will continue for five more years, after which dividend growth will revert to a normal annual rate of 8 percent into perpetuity. Also assume that the appropriate discount rate for GE is 11 percent. a. Compute the value of GE's stock at year-end 2000. b. The actual price of GE stock at year-end 2000 was $47.9375. Comparing this price to your calculation of GE's value in (a), was GE overpriced or underpriced at year-end 2000?

Answer 1

a: Dividends for next 6 years are as below

Year	Dividends
2001	0.6578
2002	0.7591
2003	0.8760
2004	1.0109
2005	1.1666
2006	1.2599

Horizon value at end of 2005 = D2006/(Required rate - growth)

= 1.2599/ (11%-8%)

=41.9959

Share price = discounted value of all the cash flows = $28.13

Since the market price is much higher, the stock is overpriced.

WORKINGS

Year	Dividends	Horizon value	Netcash flow
2001	0.6578		0.6578
2002	0.7591		0.7591
2003	0.8760		0.8760
2004	1.0109		1.0109
2005	1.1666	41.9959	43.1624
2006	1.2599
		Share price	$28.13