Lee Corp. is expected to experience a transitory turnaround period for three yea

Question

Lee Corp. is expected to experience a transitory turnaround period for three years, during which its dividends are expected to cut the current amount of $2.40 by 20% per year during the next two years, and then to grow at 50% over the following year. Afterwards, its dividends will experience sustainable growth indefinitely at an annual rate that reflects a 60% dividend payout ratio and a ROE of 25%. The discount rate is 14%. Compute the intrinsic value of Lee Corp's stock today. If the stock price for Lee Corp. is $50 today, what is your recommendation on this stock according to the intrinsic value analysis? Why? Be precise!

Explanation / Answer

(a)

(b)

Working:

Step-1: Calculate the present value of dividend upto year 3: Years 0 1 2 3 Dividend (D)           2.40           1.92           1.54           2.30 Discount factor (14%)         1.000         0.877         0.769         0.675 Present value           2.40           1.68           1.18           1.56 Total PV (1-3)           4.42 Step-2: Calculate present value of future dividend at year end 3: Present value = D3*(1+g)/(Ke-g) = 4.42*(1.10)/(.14-.10) = $ 121.55 Step-3: Present value of Step-2: = Step-2 Value* Discount factor = $ 121.55 x         0.675 = $    82.04 Step-4: (Step-1+Step-3) = $    86.46 Thus, Intrinsic value is $ 86.46

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