Dr. S. Dargil recently took his company- Filing Documents Corportation- public t
ID: 2650234 • Letter: D
Question
Dr. S. Dargil recently took his company- Filing Documents Corportation- public through an initial public offering. He is expanding the business quickly to take advantage of an otherwise unexploited market. Growth for his company is expected to be 40% for the first three years and then he expects it to slow down to a constant 15%. The most recent dividend was $0.75. Based on the most recent returns, the beta for his comapny is approximately 1.75. The risk-free rate is 4.5% and the market risk premium is 8%. What is the current price of FDC's stock?
Explanation / Answer
Solution :
Growth rate - 40% for first 3 years & then 15%
recent dividend - $0.75
Beta- 1.75
Risk free rate - 4.5%
market risk premium - 8%
As per capital aset pricing model,
Expected return = risk free rate + beta ( market return - risk free rate)
= 0.045 + 1.75 (0.08 - 0.045)
= 0.10625 i.e 10.625%
As per Gordon's Growth Model;
Dividend for year 1 - D1 = $0.75
D2 = $0.75 *1.40 = $1.05
D3 = $1.05 *1.40 = $ 1.47
Dividend after first 3 years : D4 = D3 *1.15 = $1.47 *1.15 = $1.6905
value of dividend= $1.6905 / (0.10625 - 0.15) = $38.64
Calcualtion of present values
D1 = $0.75 / 1.10625 = $0.6780
D2 = $1.05 / (1.10625)2 = $0.8580
D3 = $1.47 / (1.10625)3 = $1.0858
D4= $38.64 /(1.10625)4 = $25.80
hence,
intrinsic value = $0.6780 + $0.8580 + $1.0858 +$25.80
= $28.4218
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