Question

DAA's stock is selling for $15 per share. The firm's income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years. No dividends have been declared as yet, but the firm intends to declare a dividend of D3 = $2.00 at the end of the last year of its supernormal growth. After that, dividends are expected to grow at the firm's normal growth rate of 6 percent. Will you buy this stock? Why?

Answer 1

Answer:

This question is incomplete since the required return is not pasted here. I checked on the web and found similar question with the firm's required rate of return is 18 percent. You can use this to solve the question as follows.

Explanation:

Use Dividend Discount Model (DDM) to find the intrinsic value of the stock.

Find the present value of dividends

D3 = 2

PV(of D3) = 2/(1.18^3) = 1.2173

D4 = D3(1+g) = 2(1+0.06) = 2.12

PV(of D4) = $\frac{\frac{2.12}{0.18-0.06} }{1.18^{3} }$

PV (of D4) = 17.6667/ 1.6430 = 10.7527

Next, sum up the present values ;

= 1.2173 + 10.7527

= $11.97

Therefore, DAA's stock is currently overpriced ,so you should not buy it since it is only valued at $11.97 and not $15.