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Assume that ACM Gadget Ltd's most recent dividend was R6.50 per share. Dividends are expected
to increase by 15% annually for the next two years. At the end of the two years, it is expected that
the growth rate will drop to a 13% annual growth rate and will remain at this level for two years. At
the end of year four, it is expected that the growth rate will remain constant at 10%, ad infinitum. The
firm's cost of capital is 13%. Based on the information provided, what is the intrinsic value of the
share?



Answer :

The intrinsic value of the share is R273.66

What is the share intrinsic value?

The intrinsic value of the company's share is the present value of its future dividends discounted at the firm's cost of capital of 13%.

Current dividend=6.50

dividend growth rate for first 2 years=15%

dividend growth rate for the second 2 years=13%

terminal growth rate after year 4 =10%

Year 1 dividend=6.50*(1+15%)^1=7.4750

Year 2 dividend=6.50*(1+15%)^2=8.59625

Year 3 dividend=8.59625*(1+13%)^1=9.7137625

Year 4 dividend=8.59625*(1+13%)^2=10.976551625

Terminal value=year 4 dividend*(1+terminal growth rate)/(cost of capital-terminal growth rate

terminal value=10.976551625*(1+10%)/(13%-10%)

terminal value=402.473559583333

Each of the future dividends and terminal value can be discounted using the present value formula of single future dividends

PV=FV/(1+r)^N

FV=future dividends and terminal value

r=cost of capital=13%

N=year of cash flows, 1 for year 1 , 2 for year 2 dividends, 4 for year 4 dividend and terminal value since terminal value is also stated as the share price in year 4

intrinsic value=7.4750/(1+13%)^1+8.59625/(1+13%)^2+9.7137625/(1+13%)^3+10.976551625/(1+13%)^4+402.473559583333/(1+13%)^4

intrinsic value=R273.66

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