XYZ Ltd. recently paid a dividend of 40. The company is entering a 5-year transition phase where its current 15% growth rate will decline linearly…

CA Final · Advanced Financial Management · PYQS · May 2026
XYZ Ltd. recently paid a dividend of 40. The company is entering a 5-year transition phase where its current 15% growth rate will decline linearly to a stable perpetual rate. Financial Parameters: Transition Period: 5 years (declining linearly from Year 1).Current Data: ROE of 20% and a retention ratio of 25%.Terminal Data (Year 6+): ROE of 12% and a retention ratio of 50%.Market Data: Required return of 13% and Market Price of 850. You are required to: (i) Estimate the intrinsic value per share using the H-Model. (ii) Given the current market price of 850 per share, assess whether the stock is undervalued or overvalued and calculate the percentage deviation from intrinsic value.

Suggested Answer and Working Notes:

(i) Estimation of Intrinsic Value of share based on H Model Po= Do(1 + gn) + DoH₁(gc-gn) r-gn r-gn Where gn = Normal Growth Rate Long Run (12% x 0.50) = 6% gc = Current Growth Rate i.e. initial short term growth rate (15%) H₁ = Half of duration of the transition growth period Accordingly Intrinsic Value of share shall be: 40 (1 + 0.06) +40×2.50 (0.15-0.06) 0.13-0.06 0.13-0.06 = 605.71 +128.57 = 734.28 Thus, the intrinsic value of share shall be - 734.28. (ii) Given the current market price of 850per share, it is overvalued. The percentage deviation from the intrinsic value shall be computed as follows: = 850-734.28 = 15.76% Or 734.28 = 850-734.28 = 13.61% 850

Topics: Security Valuation

Open in Interactive Practice Hub · Full Practice Hub · Chapter Weightage · More in this subject

Related Questions in this Topic