Kruger Associates is considering a substantial investment in the stock of McIntyreEnterprises. McIntyre currently (time 0) pays a dividend of $1.50 per share. This dividend is expected to grow at 15 percent per year for the next 3 years and 10 per- cent per year for the following 3 years. McIntyre’s marginal tax rate is 40 percent. Kruger expects the value of the McIntyre stock to increase by 50 percent between now and the beginning of year 5. If Kruger requires a 12 percent rate of return on investments of this type, what value would Kruger place on the McIntyre stock?
Answer:
P0 =$ 135.77
Working notes for the above answer is as under
Here , No terminal growth rate provided, however there is an expectation that the stock priceat the end of year 4 (beginning of year 5) is 1.5 times the current stock price (i.e. an increase of 50%)
Discount dividends 1 to 4 inclusive and forecast price at time 4 to determine valueof stock today as follow
Year1
D1
=D0(1+g)
=1.5(1.15)
=1.725
Year2
D2
=D1(1+g)
=1.725(1.15)
=1.9838
Year2
D3
=D2(1+g)
=1.9838(1.15)
=2.2814
D4
=D3(1+g)
=2.2814(1.15)
=2.5095
P4
=1.5*P0
Prasent value
| Period | Dividend | PV factoe At 12% |
|
| A | B | C=A*B | |
| 1 | 1.725 | 0.892857143 | 1.540178571 |
| 2 | 1.9838 | 0.797193878 | 1.581473214 |
| 3 | 2.2814 | 0.711780248 | 1.623855457 |
| 4 | 2.5095 | 0.635518078 | 1.594832618 |
P0=1.5401+1.5815+1.6239+1.5948+1.5P0 1/(1+0.12)4
P0-1.5P0 1/(1+0.12)4=1.5401+1.5815+1.6239+1.5948
P0 (1)-0.9533 =6.3404
P0 =6.3404 / 0.9533
P0 =$ 135.77
