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Assume you have the opportunity to buy the stock of UCL plc. at an IPO being offered for 8 per share. Although you are interested

  1. Assume you have the opportunity to buy the stock of UCL plc. at an IPO being offered for 8 per share. Although you are interested in buying shares of the company, you are concerned about whether it is fairly priced. In order to determine the value of the shares, you have decided to apply the dividend discount model to value the shares. The following table summarises the dividend information you would expect in the future.

Year 1 2 3 4
Dividend 25p 35p 45p 35p

Dividends after year 4 grow at a rate of 5% per annum to infinity. The cost of equity capital is 10%.

  1. Using the dividend discount model estimate UCL plcs common stock value per share.
  2. Judging on the basis of your finding in part (i) and the stocks offering price, should you buy the stock?
  3. Upon further analysis, you find that the growth rate in UCL plcs dividends beyond year 4 will be 6.5% rather than 5%. If everything else remains the same, what effect would this finding have on your responses in parts (i) and (ii).

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