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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
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.
Expert Solution
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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