Question

Company XYZ's earnings per share is 0.8$ in 2017 and paid dividends per share is 0.48$...

Company XYZ's earnings per share is 0.8$ in 2017 and paid dividends per share is 0.48$ , the firm is expected to have earnings growth of 25% in 2018. and then this growth rate is expected to decline linearly over a 6 year period to stable growth rate of 7%. the company's beta is 0.85 , tbill rate is 6.25%. risk premium on market portfolio is 4%. assume capm holds. also assume that growth rate in initial growth phase is not a constant but declines linearly over time to reach stable growth rate
Using two stage ddm estimate the intrinsic value. how much was attributed to extraordinary growth? how about stable growth? show solution.

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Answer #1

Current dividend per share , D0 =$ 0.48

abnormal growth rate, g1 = 25% = 0.25

H = 6/2 = 3 years

normal growth, g2 = 7% = 0.07

required rate of return , r = risk free return + (beta* risk premium on market portfolio) = 6.25 + (0.85*4) = 9.65% = 0.0965

intrinsic value = value due to extraordinary growth + value due to stable growth

value due to extraordinary growth = (D0*H*(g1-g2))/(r - g2) = (0.48*3*(0.25-0.07))/(0.0965 - 0.07) = 0.2592/0.0265 = 9.781132075 or $9.78 ( rounding off to 2 decimal places)

value due to stable growth = (D0*(1+g2))/(r-g2) = (0.48*(1.07))/(0.0965-0.07) = 0.5136/0.0265 = $19.38113208 or $19.38( rounding off to 2 decimal places)

intrinsic value = 9.781132075 + 19.38113208 =$ 29.16226416 or $29.16 ( rounding off to 2 decimal places)

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