Question

In year 2008, Janet’s firm is using a two-stage dividend discount model (DDM) to find the intrinsic value of SmileWhite Co. The risk-free interest rate is 4.5% and expected return of market is 14.5% and beta of the SmileWhite Co. is 1.15. In 2008, dividend per share is $1.72 for the company. Dividends are expected to grow at a rate of 12% per year for the next three years until 2011. After 2011 dividend growth rate will be at constant rate 9% per year indefinitely.

1. Calculate the required return for SmileWhite Co. stock using the CAPM.

B. What was the intrinsic value of SmileWhite Co. stock when the analyst was evaluating the stock (that is in year 2008)?

C. If the price of SmileWhite Co. was $35.00 at the time of this evaluation process in year 2008, was the stock an overpriced or underpriced security considering the intrinsic value obtained by the two-stage DDM. What should be the trading strategy based on the evaluation

Problem 2 (continued)

3. If the price of SmileWhite Co. was $35.00 at the time of this evaluation process in year 2008, was the stock an overpriced or underpriced security considering the intrinsic value obtained by the two-stage DDM. What should be the trading strategy based on the evaluation.               (5 points)

Answer 1