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Assume Stanton Corporation will pay an annual dividend of $3.05 one year from now. Analysts expect this dividend to grow at 13% p.a. thereafter until the third year. After then, growth will level off at 3.4% p.a.. The firm’s equity cost of capital is 10.3% p.a.. What is the intrinsic value of Stanton Corporation? All of these rates are compounded annually. (Round your answer in dollars to 2 decimal places, e.g. put 1204.42 if your answer is 1204.4243.)

Question

Assume Stanton Corporation will pay an annual dividend of $3.05 one year from now. Analysts expect this dividend to grow at 13% p.a. thereafter until the third year. After then, growth will level off at 3.4% p.a.. The firm’s equity cost of capital is 10.3% p.a.. What is the intrinsic value of Stanton Corporation? All of these rates are compounded annually. (Round your answer in dollars to 2 decimal places, e.g. put 1204.42 if your answer is 1204.4243.)

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Solution

The intrinsic value of Stanton Corporation can be calculated using the Gordon Growth Model, which is a version of the Dividend Discount Model (DDM). The Gordon Growth Model assumes that dividends grow at a constant rate indefinitely.

However, in this case, we have two stages of growth: a high growth phase for the first three years, and then a stable growth phase thereafter.

Here's how to calculate it:

  1. Calculate the dividends for the first three years:

    • Year 1: $3.05
    • Year 2: 3.05∗(1+133.05 * (1 + 13%) = 3.45
    • Year 3: 3.45∗(1+133.45 * (1 + 13%) = 3.89

  2. Calculate the present value of these dividends:

    • Year 1: 3.05/(1+10.33.05 / (1 + 10.3%) = 2.77
    • Year 2: 3.45/(1+10.33.45 / (1 + 10.3%)^2 = 2.84
    • Year 3: 3.89/(1+10.33.89 / (1 + 10.3%)^3 = 2.89

  3. Calculate the dividend for the first year of the stable growth phase (Year 4):

    • Year 4: 3.89∗(1+3.43.89 * (1 + 3.4%) = 4.02

  4. Calculate the present value of all future dividends from the stable growth phase onwards, using the Gordon Growth Model:

    • PV = D / (r - g) = 4.02/(10.34.02 / (10.3% - 3.4%) = 57.43
    • But this value is as of Year 3, so we need to discount it back to today: 57.43/(1+10.357.43 / (1 + 10.3%)^3 = 42.76

  5. Add up the present values of the dividends from the high growth phase and the stable growth phase to get the intrinsic value of the stock:

    • Intrinsic Value = 2.77+2.77 + 2.84 + 2.89+2.89 + 42.76 = $51.26

So, the intrinsic value of Stanton Corporation is approximately $51.26.

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