Question

Nonconstant Growth Stock Valuation

Reizenstein Technologies (RT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, RT is expected to experience a 16% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and RT's growth rate will slow to 5% per year indefinitely. Stockholders require a return of 11% on RT's stock. The most recent annual dividend (D₀), which was paid yesterday, was $2.40 per share.

(2) Calculate the estimated intrinsic value of the stock today,  . Proceed by finding the present value of the dividends expected at t = 1, t = 2, t = 3, t = 4, and t = 5 plus the present value of the stock price that should exist at t = 5,  . The  stock price can be found by using the constant growth equation. Note that to find  you use the dividend expected at t = 6, which is 5% greater than the t = 5 dividend. Round your answer to the nearest cent. Do not round your intermediate computations.

(3) Calculate the expected dividend yield (D₁/  ), the capital gains yield expected during the first year, and the expected total return (dividend yield plus capital gains yield) during the first year. (Assume that  = P₀, and recognize that the capital gains yield is equal to the total return minus the dividend yield.). Round your answers to two decimal places. Do not round your intermediate computations.

Expected dividend yield	%
Capital gains yield	%
Expected total return	%

Also calculate these same three yields for t = 5 (e.g., D₆/  ). Round your answers to two decimal places. Do not round your intermediate computations.

Expected dividend yield	%
Capital gains yield	%
Expected total return	%

Answer 1

	Intrinsic value of the stock today=Present Value of future cash flows
			Present value of future Cash Flow=(Cash flow)/((1+R)^N)
			R=discount rate=required return=11%	0.11
			N=Year of cash flow
		D0	Recent dividend	$2.40
			g=annual growth rate for next 5 years=16%	0.16
		D1=D0*(1+g)	Dividend in year 1	$2.78
		D2=D1*(1+g)	Dividend in year 2	$3.23
		D3=D2*(1+g)	Dividend in year 3	$3.75
		D4=D3*(1+g)	Dividend in year 4	$4.35
		D5=D4*(1+g)	Dividend in year 5	$5.04
			g1=Growth rate from year 6 indefinitely=5%	0.05
		D6=D5*(1+g1)	Dividend in year 6=5.04*1.05	$5.29
		P5=D6/(R-g1)	Price of stock in year 5=5.29/(0.11-0.05)	$88.21
			N	CF	PV=CF/(1.11^N)
			Year	Cash Flow	Present Value
		D1	1	$2.78	2.508108108
		D2	2	$3.23	2.621085951
		D3	3	$3.75	2.739152886
		D4	4	$4.35	2.862538151
		D5	5	$5.04	2.991481311
		P5	5	$88.21	52.35092294
				SUM	66.07328934
		P0	Intrinsic value of the stock today	$66.07
			In Year 1
			Expected Dividend Yield =D1/P0=2.78/66.07	4.21%
			Capital Gains Yield	6.79%
			Expected Total Return	11%
			In Year 5
			Expected Dividend Yield =D6/P5=5.29/88.21	6.00%
			Capital Gains Yield	5.00%
			Expected Total Return	11.00%