Company A is current trading at 4800 a share Analysts are cu

Company A is current trading at $48.00 a share. Analysts are currently projecting the share price to be $52.50 next year. This year’s dividend was $2.88 and the company expects to grow future dividends by 4% a year.

      What would the expected rate of return be for Company A? ________________________

      If the discount rate is 10%, would there be any intrinsic value? _____________________

            If so, how much? _________________________

      If the discount rate is 20%, would there be any intrinsic value?

            If so, how much? _________________________

Solution

Facts Given : Current Share Price (P0) $48 Next Year Share Price (P1) $52.50 Current Year Dividend (D0) $2.88 Growth Rate of Dividend in Perpetuity (g) 4% Expected Rate of Return (Ke) ??? Ke= D1/p0+ g D1: D0+g =2.88(1.04) 2.9952 Expected Rate of Return (Ke)= 2.9952/48+4% 10.24% Calculation of Intrinsic Value, if the discount rate is 10% As per Gordon Growth Model which assume company in consideration is within a steady state - i.e. growing dividend in perpetuity. It is expressed as the following: Intrinsic Value of Stock : D1/ Re-g D1: Expected dividend at the end of the year Re: Required Rate of Return for Equity Investors G: Annual Growth Rate of Dividend in Perpetuity Intrinsic Value of Stock: 2.9952/ 0.10-0.04= 49.92 Intrinsic Value of Stock= $ 49.92 Calculation of Intrinsic Value, if the discount rate is 20% Intrinsic Value of Stock : D1/ Re-g D1: Expected dividend at the end of the year Re: Required Rate of Return for Equity Investors G: Annual Growth Rate of Dividend in Perpetuity Intrinsic Value of Stock: 2.9952/ 0.20-0.04= 18.72 Intrinsic Value of Stock= $ 18.72