P8.27 Fundamental to the valuation process is the determination of the intrinsic value of a security, where an investor calculates the present value of the expected future cash benefits of the invest- ment. Specifically, in the case of common stock, these future cash flows are defined by expected future dividend payments and future potential price appreciation. A simple but useful way to view stock value is that it is equal to the present value of all expected future dividends it may provide over an infinite time horizon. Based on this latter concept, the dividend valuation model (DVM) has evolved. It can take on any one of three versions-the zero-growth model, the constant-growth model, and the variable-growth model. Create a spreadsheet that applies the variable-growth model to predict the intrinsic value of the Rhyhorn Company common stock. Assume that dividends will grow at a variable rate for the next three years (2010, 2011, and 2012). After that, the annual rate of growth in dividends is expected to be 7% and stay there for the foreseeable future. Starting with the latest (2009) annual dividend of $2.00 per share, Rhyhorn's earnings and dividends are estimated to grow by 18% in 2010, by 14% in 2011, and by 9% in 2012 before dropping to a 7% rate. Given the risk profile of the firm, assume a minimum required rate of return of at least 12%. The spread- sheet for Table 8.4, which you can view on www.myfinance.lab.com, is a good reference for solving this problem. Questions

a. Calculate the projected annual dividends over the years 2010, 2011, and 2012.

b. Determine the present value of dividends during the initial variable-growth period.

c. What do you believe the price of Rhyhorn stock will be at the end of the initial growth period (2012)?

d. Having determined the expected future price of Rhyhorn stock in part

c, discount the price of the stock back to its present value.

e. Determine the total intrinsic value of Rhyhorn stock based on your calculations above.