Question

Access Fund recently paid a dividend, of $1.45. The company expects to have supernormal growth of 15% for 3 years before the dividend is expected to grow at a constant rate of 6%. The firm's cost of equity is 19%. a. Calculate the Terminal Value? What does this amount represent? b. Which cash flows would you discount, and by how many years, to find the current value of the stock? c. Which cash flows would you discount, and by how many years, to find the expected price of the stock after 1 year? d. Which cash flows would you discount, and by how many years, to find the expected price of the stock after 2 years?

Answer 1

To calculate the value of a stock with supernormal growth followed by constant growth, one must compute the present values of dividends during the high growth phase and the terminal value using the cost of equity, then discount these cash flows back to find the current and future stock prices.

Step-by-step explanation:

The provided scenario involves calculating the present discounted value (PDV) for the dividends of a stock with non-constant growth rates, to estimate the value of the stock. To find the terminal value (TV), we use the Gordon Growth Model which assumes a constant growth rate after a certain period. The terminal value is computed at the end of the supernormal growth period and it represents the present value of all future dividends growing at a constant rate from that point onward.

For Access Fund, assuming the last supernormal dividend (in year 3) is D3, the terminal value TV at the end of year 3 is given by:

TV = D3 * (1 + g) / (r - g)

Where D3 = D0 * (1 + supernormal growth rate)^3 = 1.45 * (1 + 0.15)^3

TV = D3 * (1 + 0.06) / (0.19 - 0.06)

Calculate the values to find the TV.

To find the current value of the stock, you discount the expected dividends during the supernormal growth period and the terminal value back to the present. For Access Fund:

1. 
   
3. Dividend in year 1: D1 / (1 + r)^1
4. 
   
6. Dividend in year 2: D2 / (1 + r)^2
7. 
   
9. Dividend in year 3: D3 / (1 + r)^3
10. 
    
12. Terminal value at end of year 3: TV / (1 + r)^3

Add these values to get the current stock price.

To find the expected price of the stock after 1 year, you would discount the dividends from years 2 and 3 and the terminal value, all back to the end of year 1:

1. 
   
3. Dividend in year 2: D2 / (1 + r)
4. 
   
6. Dividend in year 3: D3 / (1 + r)^2
7. 
   
9. Terminal value at end of year 3: TV / (1 + r)^2

To find the expected price of the stock after 2 years, you would discount only the dividend from year 3 and the terminal value back to the end of year 2:

1. 
   
3. Dividend in year 3: D3 / (1 + r)
4. 
   
6. Terminal value at end of year 3: TV / (1 + r)