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Homework answers / question archive / Stock A Stock B 400 100 2,575 8,450 10% Current cash dividend Current price Expected for 3 years: Growth rate Required return Expected thereafter: Growth rate Required return 18% 20% 14% 10% 12% 16% 14% a

Stock A Stock B 400 100 2,575 8,450 10% Current cash dividend Current price Expected for 3 years: Growth rate Required return Expected thereafter: Growth rate Required return 18% 20% 14% 10% 12% 16% 14% a

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Stock A Stock B 400 100 2,575 8,450 10% Current cash dividend Current price Expected for 3 years: Growth rate Required return Expected thereafter: Growth rate Required return 18% 20% 14% 10% 12% 16% 14% a. For each stock, calculate its expected cash dividend in year 4, and its expected future value at the end of 3 years, b. its present value per share Based on your calculations, are the current prices attractive? Explain. C.

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Expected future value at the end of year 3 = Div in year 4 / (Required return from year 4 onward - growth rate from year 4 onward) = D4 / (r - g)

Please see the table below. All financials are in $. Please see the second column to understand the mathematics. The cells colored in yellow contain your answer.

For stock A: Expected future value at the end of year 3 = D4 / (r - g) = 180.73 / (16% - 10%) =  3,012.23

For stock B: Expected future value at the end of year 3 = D4 / (r - g) = 585.64 / (14% - 10%) =   14,641.00

Year, n Linkage 0 1 2 3 4
Stock A            
Dividend A     100.00          118.00                139.24           164.30          180.73
Growth g   18% 18% 18% 10%
Required return r   20% 20% 20% 16%
Expected future value at the end of year 3 B              3,012.23  
Discount factors C = (1 + r)^(-n)   0.8333 0.6944 0.5787  
PV of dividends D = A x C              98.33                  96.69             95.08  
PV of terminal value E = B x C              1,743.19  
Present value per share Sum of all D's + E 2,033        
Current Price         2,575        
Since Current price > instrinsic value, the stock is overvalued and hence not attractive    
             
Stock B            
Dividend A     400.00          440.00                484.00           532.40          585.64
Growth g   10% 10% 10% 10%
Required return r   14% 14% 14% 14%
Expected future value at the end of year 3 B           14,641.00  
Discount factors C = (1 + r)^(-n)   0.8772 0.7695 0.6750  
PV of dividends D = A x C            385.96                372.42           359.35  
PV of terminal value E = B x C              9,882.26  
Present value per share Sum of all D's + E 11,000        
Current Price         8,450        
Since Current price < instrinsic value, the stock is undervalued and hence attractive    

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