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    What is the intrinsic value of the company's shares today?

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    Your company is looking to make the following annual dividend payments over the next 4 years, commencing 1 year from today: $10, $14, $7 & $2. After this time the company expects to maintain a constant growth rate of dividends of 5% indefinitely.

    1. With a required rate of return equal to 4 times the current return on government bonds (currently 3.5%), what is the intrinsic value of the company's shares today?

    2. How do you determine of the shares are overvalued or undervalued?

    3. What assumptions are you making about a shareholder investment in the company in order to justify the calculated intrinsic value in part 1?

    4. What would be the difference in your answer to part 1 if the required rate of return of the shares was only equal to only 2 times the return on government bonds? Show calculations.

    5. Explain your answer to part 4 in terms of the relationship between price and yield.

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    Solution Preview

    1. Required rate of return = 3.5%*4=14%
    Intrinsic value of shares = PV of all future dividends payments
    =PV of dividend payments for first four years + PV of value of stock at the end of 4 years.
    =10/(1+14%)+14/(1+14%)^2+7/(1+14%)^3+2/(1+14%)^4+2*(1+5%)/(14%-5%)*1/(1+14%)^4
    =$39.2686

    2. If the current market value of the share is more than $39.2686, the ...

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    $2.19

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