Question

The last dividend paid by Klein Company was $1.00. The stock’s dividend growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a constant rate of 10 percent. Klein’s required rate of return on equity (rs) is 12 percent. Based on the above, what is the intrinsic value (price) of Klein’s common stock?

Answer 1

Answer:

The intrinsic value per share today is $50.16

Explanation:

The two stage growth model of DDM is used to calculate the price of a stock whose dividends are growing by two different rates and the second rate is the one where the dividend growth becomes constant. The formula for price today under this model is,

P0 =   D0 * (1+g1) / (1+r)  +  D0 * (1+g1)² / (1+r)²  +

[ (D0 *(1+g1)² * (1+g2) / (r - g2))  /  (1+r)² ]

Where,

• g1 is the growth rate in the first period i.e. 5%
• g2 is the growth rate that is sustainable growth rate i.e. 10%

• D0 is the dividend today

P0 = 1 * (1+0.05) / (1+0.12)  +  1 * (1+0.05)² / (1+0.12)²  +

[ (1 * (1+0.05)² * (1+0.1)  /  (0.12 - 0.1))  /  (1+0.12)² ]

P0 = $50.156 rounded off to $50.16