Question

# use the following information to answer the questions. The made up company name is ABC. Price:...

use the following information to answer the questions. The made up company name is ABC.

Price: \$20

R: 12%

G: 4%

D0: 1.10

P/E: 16

EPS: 1.25

Analyst E growth: 7%

Now answer the following below using the above information that’s provided:

·      Part A-Fundamental Valuation:

1.    Estimate a growth rate for your firm's Dividends per Share.

2.    Assume a 12.5% discount rate.

3.    Calculate an estimated value of a share of the stock using the constant-growth model (Eq. 8-6 in the textbook), also known as the Gordon growth model.

4.    Compare and contrast your valuation results with the current share price in the market.

5.    Respond to this question: What changes in the variables would be necessary in your valuation to best approximate the market valuation?

·      Part B - Relative Valuation:

6.    Estimate a growth rate for your firm's Earnings per Share (EPS).

7.    Determine an applicable Price-Earnings (P/E) ratio for your firm in 5 years.

8.    Calculate an estimated value of a share of the stock in 5 years using the P/E ratio model (Eq. 8-10 in the textbook).

9.    Respond to this question: Would you characterize your stock as undervalued or overvalued? Explain.

10. Respond to this question: Based on your valuations in parts A and B, would you invest in this stock? Explain.

Solution 1

R= 12%

G =4%

Do = 1.10

Value of the stock = Do x (1+g)/ (R-g)

= 1.10 x (1+0.04)/ (0.12 – 0.04)

= \$1.144 / 0.08

= \$14.30

The value of the stock is lower than the market price of the stock. To best approximate the market valuation of the stock, the firm should increase the dividend growth rate.

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