V0 (intrinsic value) > P0 (market price) Þ buy
The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its
A stockbe
has aworth
required __________ today.
return of 12%, a dividend of $.80
per share and an expected sale price in one year of $38.00.
The intrinsic value of this stock is = E(D)+E(P)/1+K,..= 34.64
Grott and Perrin, Inc. has expected earnings of $3 per share for next
year. The firm's ROE is 20% and its earnings retention ratio is 70%. If
the firm's market capitalization rate is15%, what is the present
value of its growth opportunities? PVGO = Po(With Growth) –
Po*(No Growth). Po(With Growth) = D1/(K-G),,,. G=.2*.7,.. K=.15,,.
D1 = S(1-B) or 3(1-.7). So po = 3(1-.7)/.15-.2(.7) = 90,,. Then to solve
for Po* = D/K = E1/K or 3/.15 = 20,,. Soo Po-Po* = 90-20=70
Previous example = 50 > Po = 48, the
current market price is undervalued
compared with the intrinsic value
(undervalued) V0 (intrinsic value) < P0 (market
expected ROE is 12% and its expected EPS is $5.00. If the firm's plow-back ratio is 40%,
price) Þ sell or sell short (overvalued) In market
its P/E ratio will be,.. P0 = D1/(K-G) Step 1:. D1 = 1-b, so 1-.4=.6 Step 2: K = Market Cap
equilibrium, V0 = P0 (fairly priced) k is required
Rate Step 3: Growth = Roe*b,.. or .12*.4 or .048. So (1-0.4)/(0.1-0.12*0.4) = 11.54
return
Cache Creek Manufacturing Company is expected to pay a dividend of Westsyde Tool Company is expected to pay a dividend
$4.20 in the upcoming year. Dividends are expected to grow at the of $2.00 in the upcoming year. The risk-free rate of
rate of 8% per year. The risk-free rate of return is 4% and the return is 6%and the expected return on the market
expected return on the market portfolio is 14%. Investors use the
portfolio is 12%. Analysts expect the price of
CAPM to compute the market capitalization rate on the stock, and the
WestsydeTool Company shares to be $29 a year from
constant growth DDM to determine the intrinsic value of the stock.
now. The beta of Westsyde Tool Company's stock is
The stock is trading in the market today at $84.00. Using the constant
1.20. Using a one-period valuation model, the intrinsic
growth DDM and the CAPM, the beta of the stock is K =( D1/Po) + G
So… 4.2/84+.08 = .13. Beta = K-Rf/E®-Rf so.., (.13-.04)/(.14-.04) = .9 value of Westsyde Tool Company stock today is… Using
Intrinsic Val formula, but first by using equation above
to solve for K you set Beta of 1.2=(K-.06)/(.12-.06), so
K=.1320…, Then plug in for Vo=(2+29)/(1+.1320) = 27.39
Now, what if you decide to hold the stock for two years? In addition to
the dividend in one year, you expect a dividend of $2.10 in two years
and a stock price of $14.70 at the end of year 2. Now how much would
you be willing to pay? PV = 2 / (1.2) + (2.10 + 14.70) / (1.2)^2= 13.33
Finally, what if you decide to hold the stock for three years? In
addition to the dividends at the end of years 1 and 2, you expect to
receive a dividend of $2.205 at the end of year 3 and the stock price
is expected to be $15.435. Now how much would you be willing to
pay? PV = 2 / 1.2 + 2.10 / (1.2)^2 + (2.205 + 15.435) / (1.2)^3 = 13.33
Ace Frisbee Corporation produces a good that is very mature in their product life cycles. Ace
Frisbee Corporation is expected to pay a dividend in year 1 of$3.00, a dividend in year 2 of
$2.00, and a dividend in year 3 of $1.00. After year 3, dividends are expected to decline at the
rate of 2% per year. An appropriate required return for the stock is 8%. Using the multistage
DDM, the stock should be worth x today.
Because constant growth in yr 1 and 2, begin by solving for yr 3 using D3 and Growth in yr 3.
V3 = D3(1+G)/(K-G),.. so… 1(1-.02)/(.08)-(-.02) = 9.80…, Then to solve for Vo.., use Vo =
D1/(1+K) + D2/(1+K)^2 + D3+V3/(1+K)^3 = 3/(1.08)+ 2/(1+1.08)^2 + (1+9.8)/(1+.08)^3 = 13.06