cindy asked you to help her estimate the intrinsic value of the company\'s stock
ID: 2674939 • Letter: C
Question
cindy asked you to help her estimate the intrinsic value of the company's stock. ABC just paid a dividend of $1, and the stock now sells for $15 per share. cindy asked a number of security analysts what they believe future dividends will be, based on their analysis of the company. The consensus isthat the dividend will be increased by 10% during year 1 to 3, and at a rate of 5% per year in year 4 and thereafter. cindy asked you to use that information to estimate the required rate of return on the stock, rs, and she provided the following template for use in the analysis.Estimate rs= 10%
actual market price $15
year 0 1 2 3 4 5
dividend growth rate 10% 10% 10% 5% 5%
calculate dividends (d0 has been paid) $1 ? ? ? ? ?
P3= D4/(rs-g) Find using estimate rs ?
___________________________________________________________________________
Total CF's ? ? ?
PV's of CF's when discounted at estimate rs ? ? ?
Calculate Price= P0= Sum of PVs =
cindy told you that the growth rates in the template were just put in as tria, and that you must replace them with the analyst forecasted rate to get the forrcastes dividends and then the estimated price at year 3 (i.e. TV3 or P3 in the above table). She also notes that the estimated value for rs at the top of the template, also is a guess, and you mustreplace it with a value that will cause the calculated price shown at hte bottom to equal the actual market price. she suggests that, after you have put in the correct dividiends you can manually calculate the price, using a series of guesses as to the estimated rs. the value ofrs that causes the calculate price to equal the price is the correct one. she notes, though, that this trial-and-error process would be quite tedious, and that the correct rs could be found much faster if you replicate the above talbe in a simple excel spreadsheet. what is the value of rs?
Explanation / Answer
dividend growth rate 10% 10% 10% 5% 5% D1 = $1*1.1 = $1.1 D2 = $1.1*1.1 = $1.21 D3 = 1.21*1.1 =$1.331 D4 = $1.331*1.05 = 1.39755 P0 = $1.1/(1+r) + $1.21/(1+r)^2 + $1.331/(1+r)^3 + (1.39755/(r-5%))/(1+r)^3 $15 = $1.1/(1+r) + $1.21/(1+r)^2 + $1.331/(1+r)^3 + (1.39755/(r-5%))/(1+r)^3 r = 12.97% P3= 1.39755/(12.97%-5%) =$17.53513174 +
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