Question

Suppose you are thinking of purchasing the stock of ABC, Inc. and you expect it to pay a $2 dividend in one year from now, and dividend of $2.40 in two year from now and you believe that you can sell the stock for $13.50 at the end of year 2. If you require a return of 10% on investments of this risk, what is the intrinsic value of the stock at current time?

Answer 1

Given,

Dividend in one year = $2

Dividend in two years = $2.40

Price in two years = $13.50

Required return (r) = 10% or 0.10

Solution :-

Intrinsic value of the stock

= [Dividend in one year x (1 + r)^-1] + [(dividend in two years + price in two years) x (1 + r)^-2]

= [$2 x (1 + 0.10)^-1] + [($2.40 + $13.50) x (1 + 0.10)^-2]

= [$2 x (1.10)^-1] + [$15.90 x (1.10)^-2]

= [$2 x 0.909090909] + [$15.90 x 0.82644628099]

= $1.818181818 + $13.1404958677

= $14.96