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Assume Stanton Corporation will pay an annual dividend of $3.24 one year from now. Analysts expect this dividend to grow at 14% p.a. thereafter until the third year. After then, growth will level off at 4.1% p.a.. The firm’s equity cost of capital is 9.7% p.a.. What is the intrinsic value of Stanton Corporation? All of these rates are compounded annually. (

Question

Assume Stanton Corporation will pay an annual dividend of $3.24 one year from now. Analysts expect this dividend to grow at 14% p.a. thereafter until the third year. After then, growth will level off at 4.1% p.a.. The firm’s equity cost of capital is 9.7% p.a.. What is the intrinsic value of Stanton Corporation? All of these rates are compounded annually. (

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Solution

To calculate the intrinsic value of Stanton Corporation, we need to calculate the present value of the dividends it will pay in the future.

  1. Calculate the dividends for the first three years:

    • The dividend for the first year is given as $3.24.
    • For the second year, the dividend will grow by 14%, so it will be 3.24∗1.14=3.24 * 1.14 = 3.69.
    • For the third year, the dividend will again grow by 14%, so it will be 3.69∗1.14=3.69 * 1.14 = 4.21.

  2. Calculate the present value of these dividends:

    • The present value of the first year's dividend is 3.24/(1+0.097)=3.24 / (1 + 0.097) = 2.95.
    • The present value of the second year's dividend is 3.69/(1+0.097)2=3.69 / (1 + 0.097)^2 = 3.07.
    • The present value of the third year's dividend is 4.21/(1+0.097)3=4.21 / (1 + 0.097)^3 = 3.18.

  3. Calculate the dividend for the fourth year and onwards:

    • From the fourth year onwards, the dividend will grow at a rate of 4.1% per year. So, the dividend for the fourth year will be 4.21∗1.041=4.21 * 1.041 = 4.38.

  4. Calculate the present value of these dividends:

    • The present value of these dividends is calculated using the Gordon growth model, which is D / (r - g), where D is the dividend for the first year in this growth phase, r is the equity cost of capital, and g is the growth rate. So, the present value of these dividends is 4.38/(0.097−0.041)=4.38 / (0.097 - 0.041) = 75.52.

  5. However, this value is as of the end of the third year, so we need to discount it back to today's terms, which gives us 75.52/(1+0.097)3=75.52 / (1 + 0.097)^3 = 57.06.

  6. Finally, add up all these present values to get the intrinsic value of Stanton Corporation, which is 2.95+2.95 + 3.07 + 3.18+3.18 + 57.06 = $66.26.

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