Question

1.

1. C&D Corp’s stock is selling for $45/share. You expect dividends to be $.57/share over the next year (Year 1), $.63/share in Year 2 and $.69/share in Year 3, and you anticipate the stock will be trading at $65/share at the end of Year 3.
   1. Draw a timeline assuming all cash flows occur at the end of each year.
   2. If you have estimated C&D Corp’s Cost of Equity to be 7.8%, what do you believe the true value of the stock is today?
   3. Given your answer to 4. b., what would you recommend to your clients?
2. On average, C&D Corp can earn 10%/year after tax on new investments. If its dividend payout ratio averages 25%, how fast would you expect its net income to grow/year?

Answer 1

Answer:

a.) Timeline of all Cashflows

Year End 1	Year End 2	Year End 3	Year End 3
Dividend = $ 0.57	Dividend = $ 0.63	Dividend = $ 0.69	Share Price = $65

b. ) Calculation of true value of Stock Today

Below is the table showing Disconted cash flows

Year	Dividend / Share Price	Discountinf factor @ 7.8 %	Discounted Cash Flows
1	0.57	0.9276	0.5287
2	0.63	0.8605	0.5421
3	0.69	0.7983	0.5508
3	65	0.7983	51.8895
		Total	$ 57.5111

The true value of Stock Today is $ 57.5111.

c.) Based on Stock price of $ 57.5111 ,the stock price of $45 per share is underpriced.Hence Recommendation is to buy the stock.

Calulation of Growth Rate

g = b * r

where g is growth rate

b is retention ratio [Retention ratio = 100% - Dividend Payout ratio] (i.e 100% - 25% = 75 % )

r is after tax Return (i.e 10 %)

g = 0.75 * 0.10

=0.075 or 7.5 %