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The Duo Growth Company just paid a dividend of $1 per share
The Duo Growth Company just paid a dividend of $1 per share. The dividend is expected to grow at a rate of 25% over the 3 following years starting this year, and then to level off to 5% per year forever. You think the appropriate market capitalization rate is 20% per year. a) What is your estimate of the intrinsic value of a share of the stock now? b) If the market price of a share is equal to this intrinsic value, what is the expected dividend yield? c) What do you expect its price to be 1 year from now? Is the implied capital gain consistent with your estimate of the dividend yield and the market capitalization rate?
Expert Solution
a) Intrinsic value is simply present value of all future cashflow
| Year | Working | Dividend | PVF @ 20% | PV |
| 1 | 1(1+0.25) | 1.250 | 0.833 | 1.042 |
| 2 | 1.25(1+0.25) | 1.563 | 0.694 | 1.085 |
| 3 | 1.563(1+0.25) | 1.953 | 0.579 | 1.130 |
| 4 Onwards | 1.953(1+0.05) | 2.051 | 7.912 | |
| Total | 11.169 |
PV of 4 year onwards dividend = D4 /Ke - g * PVF (20% , 3)
=2.051/0.20 - 0.05 * 0.579 =7.912
b) If market price is equals intrinsic value then expected dividend yield will be = Dividend / MPS *100
=1.25/11.169 * 100 = 11.19%
c) Expected price = P0(1+Ke) - D1
= 11.169(1 + 0.20) - 1.25
= 12.1528
Here capital gain yield = P1 - P0 / P0 * 100
=12.1528 - 11.169 / 11.169 * 100
= 8.81%
Total Yield = Dividend Yield + capital gain Yield = 11.19 + 8.81 = 20% consistent to market capitalisation rate.
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