Four years ago, XYZ company paid a dividend of $0.80 per share. Today XYZ paid a...

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Four years ago, XYZ company paid a dividend of $0.80 per share.Today XYZ paid a dividend of $1.66 per share. It is expected thatthe company will pay dividends growing at this same rate for thenext 5 years. Thereafter, the growth rate will level off at 8% peryear. The current stock price is $30. If the required return onthis stock remains at 18%, should you buy the stock?
Please show all steps. Don't round off until you get to theend.

Answer & Explanation Solved by verified expert

3.9 Ratings (468 Votes)

Annual average growth rate=((last value/First value)^(1/Time between 1st and last value)-1)*100

Annual Growth rate=((1.66/0.8)^(1/4)-1)*100

Annual Growth rate% = 20.02

	Required rate=	18.00%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	1.66	20.02%	1.992332		1.992332	1.18	1.6884
2	1.992332	20.02%	2.391196866		2.391196866	1.3924	1.71732
3	2.391196866	20.02%	2.869914479		2.869914479	1.643032	1.74672
4	2.869914479	20.02%	3.444471358		3.444471358	1.93877776	1.77662
5	3.444471358	20.02%	4.134054524	44.648	48.78205452	2.287757757	21.32309
	Long term growth rate (given)=	8.00%			*Value of Stock =*	*Sum of discounted value =*	28.25

Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year

Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 5 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

Donot buy as CMP of 30 is more than 28.25 (intrinsic value)

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Transcribed Image Text

Four years ago, XYZ company paid a dividend of $0.80 per share.Today XYZ paid a dividend of $1.66 per share. It is expected thatthe company will pay dividends growing at this same rate for thenext 5 years. Thereafter, the growth rate will level off at 8% peryear. The current stock price is $30. If the required return onthis stock remains at 18%, should you buy the stock?Please show all steps. Don't round off until you get to theend.