Question

Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 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 $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value?

Year: 0 1 2 3 4 5 6

Growth rate: NA NA NA NA 30.00% 15.00% 8.00%

Dividends: $0.000 $0.000 $0.000 $0.250 $0.325 $0.374 $0.404 ​

Question options: $8.60 $9.29 $10.50 $9.21 $10.75

Answer 1

current value of stock= present value of dividends stream where discounting rate is the requireds rate of return of 11%

step1 calculate present value of explicit forecast period of 5 years

present value of

dividend of o.25 receives at end of 3 years= 0.25 x 0.731= 0.1828

dividend of 0.325 received at end of 4 yrs= 0.325 x 0.659= 0.2142

dividend of 0.374 recd at end of 5 yrs= 0.374 x 0.593=0.2218

total of the present values calculated above= 0.6188

step2 calculate present value of terminal value

after 5th year dividend will grow at a steady rate of 8%

So cash flow in the 6th year= 0.404

CONTINUING VALUE/TERMINAL VALUE=   FCF₆ / r-g where FCF6 is the free cashflow at the end of explicit forecast period of 5 years, r is the rate of return= 11% or 0.11 and g is the growth rate of 8% or 0.08

terminal value= 0.404/(0.11-0.08) = 0.404/0.03= 13.4666

present value of terminal value= 13.4666 x present value factor at 11% for 5 yrs= 13.4666 X 0.593= 7.99

step 3: add the present values so obtained

= 0.6188 +7.99= $8.60