Micro Corp. just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5 percent next year, 15 percent in year two, and 25 percent in year 3. After that growth is expected to level off to a constant growth rate of 10 percent per year. The required rate of return is 15 percent. Calculate the intrinsic value using the multistage model.

Question

Quizplus · Accepted Answer

Using the multistage model, we can calculate the intrinsic value as follows:

Year 1: D1 = $2 x 1.05 = $2.10
Year 2: D2 = $2.10 x 1.15 = $2.42
Year 3: D3 = $2.42 x 1.25 = $3.03
Year 4: D4 = $3.03 x 1.10 = $3.33

Using the constant growth model:
P4 = D4 / (r - g) = $3.33 / (0.15 - 0.10) = $66.60

Discounting back to present value:
PV(P4) = $66.60 / (1 + 0.15)^3 = $41.38

PV(D1) = $2.10 / (1 + 0.15)^1 = $1.83

PV(D2) = $2.42 / (1 + 0.15)^2 = $1.82

PV(D3) = $3.03 / (1 + 0.15)^3 = $1.67

PV of all dividends = $1.83 + $1.82 + $1.67 = $5.32

Adding the present value of the price in year 4:
Intrinsic value = PV of all dividends + PV(P4) = $5.32 + $41.38 = $46.70

Therefore, the correct answer is C) $49.31, which is the closest answer choice to our calculated intrinsic value.