Question

Robert Campbell and Carol Morris, senior vice presidents of the Mutual of Chicago Insurance Company, have a major new client that has requested that they present an investment seminar to illustrate the stock valuation process. As a result, Campbell and Morris have asked you to analyze the Bon Temps Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. You are to answer the following questions:

- Assume that Bon Temps is a constant growth company whose last
dividend (D
_{0}, which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6 percent rate. The appropriate rate of return for Bon Temps’ stock is 16 percent.

- What is the firm’s expected dividend stream over the next three years?
- What is the firm’s current stock price?
- What is the stock’s expected value one year from now?
- What are the expected dividend yield, the capital gains yield, and the total return during the first year?

- Assume that Bon Temps’ stock is currently selling at $21.20. What is the expected rate of return on the stock?
- What would the stock price be if its dividends were expected to have zero growth?
**Now assume that Bon Temps is a non-constant growth stock, the first three years in business they experience a growth rate of 18%, then it slows to 6%. Calculate the value of the stock, assuming the required rate of return is 20%. The last dividend paid, D**_{0}is $1.50.

**I only need the last part, part D, answered.

Answer #1

To find the value of the firm in this case , we need to use the multistage dividend growth model.

D0 | 1 | 2 | 3 | perpetuity |

1.5 | 1.77 | 2.0886 | 2.464548 | 11.35714 |

PV | ||||

1.475 | 1.450417 | 1.426243 | 6.572421 | |

value | 10.92408 |

In the above table, the first row shows the Do, and the value of the dividend for the next 3 years based on 18% growth rate. The perpetuity value is found out using the gordon growth model which is dividend on 3rd year*(1+growth rate)/(WACC-growth rate)

putting in all the values we get the final values of dividend.

we then find the present value of each dividend by discounting them to current period. and then we sum them all tp get the value of 10.92

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