Question

An analyst uses the constant growth model to evaluate a company with the following data for a company:

Leverage ratio (asset/equity): 1.8

Total asset turnover: 1.5

Current ratio: 1.8

Net profit margin: 8%

Dividend payout ratio: 40%

Earnings per share in the past year: $0.85

The required rate on equity: 15%

Based on an analysis, the growth rate of the company will drop by 25 percent per year in the next two years and then keep it afterward. Assume that the company will keep its dividend policy unchanged.

Determine the growth rate of the company for each of next three years.

Use the multi-period DDM to estimate the intrinsic value of the company’s stock.

Suppose after one year, everything else will be unchanged but the required rate on equity will decrease to 14%. What would be your holding period return for the year?

Answer 1

Answer:

Given data

  Growth rate of the company = Retention ratio x return on equity

Here retention ratio = 1 - dividend payout ratio = 1 - 0.4 = 0.6

And return on equity = 15%

Therefore growth rate = 0.6 x 15% = 9%

Growth rate in the first year = 9% x (1-0.25) = 6.75%

Growth rate in the second year = 6.75% x (1-0.25) = 5.0625%

Now

Here dividend per share = dividend payout x EPS = 40% x $0.85 = $0.34 per share

year	Dividend	PV
1	0.36295	$0.32
2	0.381324	$0.29
3	0.400629
PV of dividends -=		$0.60
P2 =	4.031486
and p V of P2 =		$3.05
So total intrinsic value =			$3.65