Question
Q3 As a professional analyst you are responsible for valuing stocks. After gathering data on the Bluth Company you have estimated that its dividend has been growing at a rate of 6.5% per year. You also estimate that next year’s dividend will be $2.34 per share. The stock is currently selling at $51.55 per share, and you believe that an appropriate discount rate is 14%. You expect that the dividend will continue to grow at 6.5% for the foreseeable future. What is the highest price you would recommend your clients pay to purchase this stock? (5 points) Stock Price Next Dividend Growth Rate Required Return Valuation $51.55 $ 2.34 6.5% 14.0% Based on your valuation, would you say the stock is overvalued or undervalued? (2 points) Overvalued or Undervalued? Suppose that after looking at the company more closely you decide that it is getting close to maturity, and you think that the dividend will only grow at 6.5% for 8 more years. After that, you think it will only grow at 2%. What is your new valuation? (5 points) Stock Price Next Dividend Growth Rate 1 Growth Rate 2 Required Return Valuation $ 51.55 $ 2.34 6.5% 2.0% 14.0%
Answer
1. Value of Stock=D1/(required rate-growth rate)=2.34/(14%-6.5%)=31.2
2. The stock is overvalued becasue it is trading at lower than market price.
3. D1=2.34
D2=2.34*(1+6.5%)=2.492
D3=2.492*(1+6.5%)=2.654
D4=2.654*(1+6.5%)=2.827
D5=2.827*(1+6.5%)=3.01
D6=3.01*(1+6.5%)=3.206
D7=3.206*(1+6.5%)=3.414
D8=3.414*(1+6.5%)=3.636
D9=3.636*(1+6.5%)=3.873
D10=3.873*(1+2%)=3.95
Terminal value at Year9=D10/(required arte-growth rate)=3.95/(14%-2%)=32.92
Value of Stock=(D1/(1+14%))+(D2/(1+14%)^2)+(D3/(1+14%)^3)+(D4/(1+14%)^4)+(D5/(1+14%)^5)+(D6/(1+14%)^6)+(D7/(1+14%)^7)+(D8/(1+14%)^8)((D9+Terminal value at year9)/(1+14%)^9)
=2.053+1.918+1.791+1.674+1.563+1.461+1.365+1.275+11.313
=24.41
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