The Duo Growth Company just paid a dividend of $4.4 per share. The dividend is e

Question

The Duo Growth Company just paid a dividend of $4.4 per share. The dividend is expected to grow at a rate of 20% per year for the next 3 years and then to level off to 10% per year forever. You think the appropriate market capitalization rate is 13% per year.

a. What is your estimate of the intrinsic value of a share of the stock? Round your answer to 2 decimal places.

b. If the market price of a share is equal to this intrinsic value, what is the expected dividend yield? Round your answer to 1 decimal place.

c. What do you expect its price to be 1 year from now? What is the implied capital gain? (Round your answers to 2 decimal places.

Explanation / Answer

Part -A

D0 = 4.4

D1 = 4.4* 1.2 = 5.28

D2 = 5.28*1.2 = 6.336

D3 = 6.336*1.2 = 7.6032

D4 = 7.6032*1.1 = 8.36352

According to dividend distribution model (DDM), P3 = D4/(Ke-g)

Ke = 13% =0.13

g = 10% =0.1

P3 = 8.36352/(0.13-0.1)

Price in year 3 = P3 = 278.784

Hence instrinsic value of the stock today = 5.28/1.13 + 6.336/1.13^2 + 7.6032/1.13^3 + 278.784/1.13^3 = 208.12

Instrinsic value of the stock today = $208.12

b. Dividend yield = 4.4/208.12 =0.0211 =2.1%

c.  Price after 1 year will be =6.336/1.13 + 7.6032/1.13^2 + 278.784/1.13^2 = 229.89

Capital gains yield = (229.89 -208.12)/208.12 = 0.1046 =10.46%

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