Question

Larry and Curley are brothers.? They're both serious? investors, but they have different approaches to valuing stocks.? Larry, the older? brother, likes to use the dividend valuation model. Curley prefers the free cash flow to equity valuation model. As it turns? out, right?now, both of them are looking at the same stocklong dash—American Home Care? Products, Inc.?(AHCP). The company has been listed on the NYSE for over 50 years and is widely regarded as a? mature, rock-solid,? dividend-paying stock. The brothers have gathered the following information about? AHCP's stock:

Current dividend

?(Upper D 0D0?)equals=?$2.10?/share

Current free cash flow

?(FCF 0FCF0?)equals=?$1.0 million

Expected growth rate of dividends and cash flows (g?)equals=8?%

Required rate of return ?(r?)equals=13?%

Shares outstanding equals=450,000 shares

Answer 1

Solution :-

a) Valuation of share for Larry

            Value of stock using DDM model is calculated below:

Stock Price = Current Dividend × (1 + Growth rate) / (Required rate - Growth rate)

= $2.10 × (1 + 8%) / (13% - 8%)

= $2.268 / 5%

= $45.36

The stock price from? DDM for Larry is ?$45.36

b) For Curley:-

Valuation using FCF

Value of firm = FCF0 × (1 + Growth rate) / (Required rate - Growth rate)

= $1,000,000 × (1 + 8%) / (13% - 8%)

= $1,080,000 / 5%

= $21,600,000

Value of firm is $21,600,000

Number of share outstanding = 450,000

Stock Price = $21,600,000/ 450,000

= $48.00

The stock price from? cash flow method is ?$48.00.

Please feel free to ask if you have any query in the comment section.