Question

Indigo Ink Supply paid a dividend of $5.5 last year on its common stock. It is expected that this dividend will grow at a rate of 9% for the next five years. After that, the company will settle into a slower growth pattern and plans to pay dividends that will grow at a rate of 4% per year. Investors require a return of 12% on the stock.

a. What will be the dividend paid out for the next six years? (Round your answers to 4 decimal places.)
b. What is the intrinsic value of Indigo?s stock? (Round your answer to 2 decimal places.)

Answer 1

a.

Find dividends below

b.

$88.34

Step-by-step explanation:

a.

To begin with, the forecast future dividend can be determined as the current dividend multiplied by the growth factor.

Year 1 dividend=last year dividend*(1+growth rate)

last year dividend=$5.5

growth rate=9%

Year 1 dividend=$5.5*(1+9%)

Year 1 dividend=$6.00

Year 2 dividend=$6.00*(1+9%)=$6.54

Year 3 dividend=$6.54*(1+9%)=$7.13

Year 4 dividend=$7.13*(1+9%)=$7.77

Year 5 dividend=$7.77*(1+9%)=$8.47

Note from year 6 onward, the dividend growth rate is 4%

Year 6 dividend=$8.47*(1+4%)=$8.81

b.

The intrinsic value of Indigo's stock is the present value of its future dividends(years 1-5) and the present value of terminal value beyond year 5

terminal value=year 5 dividend*(1+terminal growth rate)/(required rate of return-terminal growth rate)

year 5 dividend=$8.47

terminal growth=4%

the required rate of return=12%

terminal value=$8.47*(1+4%)/(12%-4%)

terminal value=$110.11

PV of future dividend=dividend/(1+cost of equity capital)^n

intrinsic value=$6.00/(1+12%)^1+$7.13/(1+12%)^2+$7.13/(1+12%)^3+$7.77/(1+12%)^4+$8.47/(1+12%)^5+$110.11/(1+12%)^5

intrinsic value=$88.34