Question

Bed Bath & Beyond Inc., (BBBY) together with its subsidiaries, operates a chain of retail stores. The company sells a range of domestics’ merchandise, including bed linens and related items, bath items, and kitchen textiles; and home furnishings, such as kitchen and tabletop items, fine tabletop, basic housewares, general home furnishings, consumables, and various juvenile products. BBBY just paid a year-end dividend of $2.00. Investors expect the dividends to grow at 20% for the next three years and after which the dividend is expected to grow at a rate of 7% forever. BBBY’s stockholders require a rate of rate of return of 15%. BBBY’s stock is currently trading at $42.  

Required:

Calculate the price (intrinsic value) of BBBY’s stock and discuss whether this stock is over or undervalued.

Answer 1

Intrinsic Value = [ D₀ ( 1 + g )¹ / ( 1 + r ) ] + [ D₀ ( 1 + g )² / ( 1 + r )²   ] + [ D₀ ( 1 + g )³ / ( 1 + r )³ ] + [ D₀ ( 1 + g )³ (1 + g₁ ) / ( R_e - g ) ( 1 + r )³ ]

                      = [ 2 * 1.20 / 1.15 ]+ [ 2 * 1.20² / 1.15² ] + [ 2 * 1.20³ / 1.15³ ] + [ 2 * 1.20³ * 1.07 / 1.15³ * ( 0.15 - 0.07 ) ]

                      = 2.09 + 2.18 + 2.27 + 30.39

                      = $ 36.93 Answer

Intrinsic value is less than actual price and hence the stock is overvalued.