Deployment Specialists pays a current (annual) dividend of $1.00 and is expected to grow at 20% for 2 years and then at 4% thereafter. If the required return for Deployment Specialists is 8.5%, what is the intrinsic value of its stock?

The correct answer to the following question is $30.60.

Explanation:

The given information -

Present dividend (D0) - $1

Dividend growth rate for the first 2 years (G1) - 20%

after 2 years it is (G2) - 4%

Required return for specialist (R) - 8.5%

Here for calculating the intrinsic value, the first thing to do would be to take out the dividend for the year 1 and 2, so to calculate the formula used would be -

Dividend for year 1 = D0 X (1+G1)

= $1 X (1 + 20%)

= $1.20

Dividend for year 2 = D0 X (1+G1)

= $1.20 X (1 + 20%)

= $1.44

After this the next thing to do is to take out terminal value, were we will use the growth rate of 4%

= Dividend for second year x (1+G2) / (R - G2)

= $1.44 X (1 + 4%) / (8.5% - 4%)

= $33.28

Now we will calculate the intrinsic value with the formula,

Dividend year 1 / (1 + R) ^1 + (Dividend year 2 + Terminal value) / (1+R) ^2

= $1.20 / (1+8.5%) + $1.44 + $33.28 / (1+8.5%)

= $1.1060 + $29.4931

= $30.599

= $30.60