Agarwal Technologies was founded 10 years ago. It has been profitable for the la

Question

Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $o.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's orecast of the uture dividend stream, along with the forecasted growth rates, 1s shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value? Year Growth rate Dividends 10 NA 4 30.00% NA NA NA 15.00 % 8.00% 0.000 $0.000 $0.000 .250 $0.325 $0.374 $0.404

Explanation / Answer

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

Future cash flows are dividends and terminal value at the end of 6th year (as dividends will be constant thereafter)

Terminal value

= Expected dividend in year 7 / ( Re – G)

Where,

Expected dividend in 7th year

= Dividend of 6th year x (1 + Growth)

= $0.404 x (1.08)

= $0.436

Re = Required rate of return on the stock = 11% or 0.11

G = Growth rate = 8% or 0.08

So, Terminal value

= $0.436 / (0.11 – 0.08)

= $14.531

Present value factor

= 1 / (1 + Re) ^ n

Where,

Re = Required rate of return= 11% or 0.11

n = Years = 3 to 6

So,
PV Factor for year 3

= 1 / (1.11) ^ 3

= 1 / 1.367631

= 0.731191

The value of share today is calculated as below

So, the estimated price is $8.60

Calculations A B C = A x B Year Cash Flows PV Factor Present Value 3 0.25 0.731191 0.182798 4 0.325 0.658731 0.214088 5 0.374 0.593451 0.221951 6 0.404 0.534641 0.215995 6 14.531 0.534641 7.768866 Total 8.60

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