Question

Phoenix industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another two years (the dividend in year 2 will be $2 and the dividend in year 3 will be $3). After the third year (in which dividends are $3 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 6%. Assume that the firm’s investors expect to earn a return of 14% on this stock.

What is the terminal price of the Phoenix industries at the end of year 3, that is, what is P3 ?

What is the intrinsic value of the Phoenix industries’ stock, that is, what is P0 ?

If the current price of the stock in the market is $18 per share, the Phoenix industries’ stock is (compared to its intrinsic value)

Answer 1

	Required rate=	14.00%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Terminal value	Total Value	Discount factor	Discounted value
1	0	0.00%	1		1	1.14	0.8772
2	1	0.00%	2		2	1.2996	1.53894
3	2	0.00%	3	39.75	42.75	1.481544	28.85503
	Long term growth rate (given)=	6.00%			Intrinsic value=	Sum of discounted value =	31.27

Where
Total value = Dividend + Terminal value (only for last year)
Horizon value = Dividend Current year 3 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

Market price is underpriced compared to intrinsic value