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

	Required rate=	11.00%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	0.57	15.40%	0.65778		0.65778	1.11	0.5926
2	0.65778	15.40%	0.75907812		0.75907812	1.2321	0.61608
3	0.75907812	15.40%	0.87597615		0.87597615	1.367631	0.64051
4	0.87597615	15.40%	1.010876478		1.010876478	1.51807041	0.6659
5	1.010876478	15.40%	1.166551455	41.996	43.16255146	1.685058155	25.61487
	Long term growth rate (given)=	8.00%			Value of Stock =	Sum of discounted value =	28.13

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 5 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

b

Stock was over priced as market price is more than intrinsic value