Question 4 You are offered three stocks at various prices, but aren’t sure if th
ID: 2729881 • Letter: Q
Question
Question 4
You are offered three stocks at various prices, but aren’t sure if the prices are reasonable. So you decide to determine the fair price of each given some additional information you found.
Stock Name t=1 Dividend Initial Growth Later Growth
Pie $4.50 3.5% 3.5% forever
Row $8.50 None (flat) Still flat at $8.50 forever
Sigmah $3.70 12% annually for next 10 years Flat thereafter (DIV12+=DIV11) forever
Your assumed discount rate is 9%. What is the price of each stock?
Explanation / Answer
Fair price of Stock Pie = $4.50 * (1 + 3.5%) / (9% - 3.5%)
= $84.68
Fair price of Stock Row = $8.50 / 9%
= $94.44
Fair price of Stock Sigma = $3.70 * (1 + 12%) / (1 + 9%) + $3.70 * (1 + 12%)2 / (1 + 9%)2 + $3.70 * (1 + 12%)3 / (1 + 9%)3 + $3.70 * (1 + 12%)4 / (1 + 9%)4 + $3.70 * (1 + 12%)5 / (1 + 9%)5 + $3.70 * (1 + 12%)6 / (1 + 9%)6 + $3.70 * (1 + 12%)7 / (1 + 9%)7 + $3.70 * (1 + 12%)8 / (1 + 9%)8 + $3.70 * (1 + 12%)9 / (1 + 9%)9 + $3.70 * (1 + 12%)10 / (1 + 9%)10 + $3.70 * (1 + 12%)3 / [(1 + 9%)3 * 9%]
= $97.02
= $81.82
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