The Pentire Corporation is looking to make the following annual dividend payments over the next four years, commencing one year from today: $10, $14, $7 and $2 respectively. After this time (four years from today) , the company expects to maintain indefinitely a constant growth rate in dividends of 5% p.a., that is, the year 5 dividend will be equal to the year 4 dividend increased by 5%. Assume the current required rate of return from an investment in Pentire Corporation is equal to 4 times the current nominal rate of return on government bonds. The most recent issue of government bonds were at a coupon rate of 6% p.a. compounding semi-annually and currently provide a nominal market yield to bondholders of 3.5% p.a., also compounding semi-annually.
Required:
a) Set out the relevant cash flows and information provided above on a time / cash-flow diagram to assist your financial calculator input.
b) i) Showing all calculations, what would be the intrinsic value of Pentire Corporation shares today? Note: For the purposes of this course, an intrinsic value represents a calculated value based on the application of relevant formulae – such value is often used as a ‘benchmark’ for subsequent decision-making
ii) In what way can the calculated intrinsic value of Pentire Corporation shares in part b) i) of this question be used to assess whether the company’s shares are currently overvalued or undervalued?
iii) Explain what assumptions are you making about a shareholder investment in Pentire Corporation shares (from the perspective of both the shareholder and the company), in order to justify the use of the calculated intrinsic value and discussion in parts b) i) and b) ii) of this question. Hint: If you were using the calculations and discussion from parts b) i) and b) ii) of this question to give financial advice to a client, what additional disclosures would it be prudent / necessary to provide to the client before any decisions were implemented?
