Question
1. Two analysts are given the task to estimate the intrinsic value of firm XYZ. Analyst 1 uses a dividend discount model (DDM) with a
1. Two analysts are given the task to estimate the intrinsic value of firm XYZ. Analyst 1 uses a dividend discount model (DDM) with a constant growth rate of 4% per annum and a required rate of return of 8% per annum. According to his estimation, XYZs intrinsic value is $20.
(a) Calculate the expected dividend per share (according to analyst 1s estimation) to be paid by firm XYZ a year from now.
Analyst 2 estimates that shareholders of firm XYZ will only receive the expected dividend per share found in part (a) in 5 years time (instead of 1 year). She also uses a constant DDM with a higher assumed growth rate of 6% per annum and a required return of 10% per annum.
(b) Calculate the intrinsic value of firm XYZ according to analyst 2s estimation.
Jenny just paid $16 today to buy a share of XYZ. Jenny forecasts that a dividend of $0.60 will be paid a year from now. Consider the following three possible scenarios for the shares price exactly 1 year from now (immediately after the dividend payment): (
i) Scenario 1: the share price is exactly analyst 1s estimated instrinsic value (i.e., $20) with a probability of 60%.
(ii) Scenario 2: the share price remains the same at $16 with a probability of 15%.
(iii) Scenario 3: the share price is exactly analyst 2s estimated intrinsic value (i.e., the answer in part (b)) with a probability of 25%.
(c) Calculate the expected return for Jenny if she holds stock XYZ for 1 year under the assumptions stated above. (5 marks)
Please use a financial calculator to solve.
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