Final answer:
To calculate the intrinsic value of Starbucks Corporation's stock, you need to discount the projected dividends for the first 3 years and then apply the Gordon Growth Model to determine the present value of all subsequent dividends growing at a stable rate.
Step-by-step explanation:
The intrinsic value of a company's stock can be determined by calculating the present value of its expected future dividends. For Starbucks Corporation, which has just paid a dividend of $3 and is projected to pay dividends of $3.70, $3.75, and $3.80 in Years 1, 2, and 3 respectively, followed by a stable growth rate of 2% thereafter, we must discount these future cash flows by the required rate of return, which is 8%.
To calculate the intrinsic value, we first discount the known future dividends for the first three years. Then we use the Gordon Growth Model (a perpetuity formula) to calculate the present value of all dividends expected after the third year, when the growth stabilizes at 2%. The formula for the Gordon Growth Model is P = D / (r - g), where P is the present value, D is the dividend at the start of the stable period, r is the required rate of return, and g is the growth rate of dividends.
Considering the information provided in your case about Babble, Inc., an investor would calculate the present value of the future dividends to determine how much they would pay for a share of stock in the company. The dividends expected are $15 million immediately, $20 million one year from now, and $25 million two years from now, paid out of the total profits. These dividends are to be divided by the number of shares, 200, and each share's value would be the present value of these dividend payments.
In summary, to find the intrinsic value of a stock, you must account for the present value of all future dividends using the required rate of return to discount them. This includes any special situations such as the termination of the company, where only a few dividends are expected. Finally, historical context from Table 17.2 indicates that dividend yield percentages have fluctuated over time, showing the importance of understanding the changing nature of stock returns.