Kruger Associates is considering a substantial investment in the stock of McInty

Question

Kruger Associates is considering a substantial investment in the stock of McIntyre Enterprises. McIntyre currently (time 0) pays a dividend of $1.50 per share. This dividend is expected to grow at 15 percent per year for the next 3 years and 10 per- cent per year for the following 3 years. McIntyre’s marginal tax rate is 40 percent. Kruger expects the value of the McIntyre stock to increase by 50 percent between now and the beginning of year 5. If Kruger requires a 12 percent rate of return on investments of this type, what value would Kruger place on the McIntyre stock?

Explanation / Answer

Year Nature Cashflow PV Factor @ 12% Discounted Cashflow A B A*B 1 Dividend           1.73 0.8929                1.54 2 Dividend           1.98 0.7972                1.58 3 Dividend           2.28 0.7118                1.62 4 Dividend           2.51 0.6355                1.59 4 Market Price at the beginning of Year 5      138.02 0.6355              87.71 Intrinsic Value of Stock today              94.05 Price of Stock at the beginning of Year 5 = $138.02 Price of Stock Kruger is willing to pay today = $138.02/2 = $69.01 Dividend Calculations Year Calculation Amount 1 D1 = 1.5 * 1.15           1.73 2 D2 = D1 * 1.15           1.98 3 D3 = D2 * 1.15           2.28 4 D4 = D3*1.10           2.51 5 D5 = D4*1.10           2.76 Market Price at the end of Year 4 = D5 / (Re - g) = 2.76 / (0.12 - 0.10) = 138.02

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