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Dividend Discount Model

Constant Dividend/ Zero Growth P = D/R

Dividend Growth Model


D 0 (1  g) D
P0  
R -g R-

g = (retention ratio *
g = ( 1- payout ratio *
— Dividend yield
D1/P0 = Dividend/Current Price
— Capital gains yield
(P1 – P0)/P0
Change in the Price/ beginning Price
— Total return (rs)
Dividend yield + Capital gains yield

Q. 1

Fee Founders has perpetual stock outstanding that sells for $60 a share and pays a dividend of $5 at the end of each
the required rate of return?

Q. 2

Allied Food Products just paid a dividend of $1.15, and the dividend is expected to grow at a constant rate of 8.3%
consistent with these numbers, assuming a 13.7% required return?
Allied Food Products just paid a dividend of $1.15, and the dividend is expected to grow at a constant rate of 8.3%
consistent with these numbers, assuming a 13.7% required return?

Q.3
You buy a stock for $23.06, and you expect the next annual dividend to be $1.245. Furthermore, you exp
constant rate of 8.3%. What is the expected rate of return and dividend yield on the stock? If the curret trad
capital gain yield?

Q.4

A company just paid a $1.15 dividend, and it is expected to grow at 30% for the next 3 years. After 3 years th
to grow at the rate of 8% indefinitely. If the required return is 13.4%, what is the stock's value

D0
rs
gs Short-run g; for Years 1-3 only.
gL Long-run g; for Year 4 and all following years.
Q.5

A perpetual preferred stock pays a $10 annual dividend and has a required return of 10.3%. What is its valu

D
R
P

Q6. If D1 = $2.00, g = 6%, and P0 = $40, what is the stock’s expected dividend yield, capital gains yield, and total
expected return for the coming year? If P1 = $45.
D1
g
P0

Exp. dividend yield Dividend/Price


Exp. capital gains yield (P1-P0)/P0
Exp. total return Dividend Yield + Capital gains Yield

Q. 7
A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs =
11%. Other things held constant, what would the stock’s price be if the growth rate was 5%?

D1
g
rs

Price = D1/(r-g)
Stock price

Q. 8

A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs =
11%. Other things held constant, what would the stock’s price be if the growth rate was 0%?

D1
g
rs
Price
Q. 9 Firm B has a 12% ROE. Other things held constant, what would its expected growth rate be if it
paid out 25% of its earnings as dividends?

ROE g = (1-payout ratio) * ROE


Payout ratio
g

Q. 9 b
What would its expected growth rate be if it paid out 75% of its earnings as
dividends?

g = (1 – payout)ROE =
iscount Model

 g) D1

g R -g

on ratio * ROE)
out ratio * ROE)

vidend of $5 at the end of each year. What is

grow at a constant rate of 8.3%. What stock price is


% required return?
$1.245. Furthermore, you expect the dividend to grow at a
n the stock? If the curret trading price is $29 what will be the
?

next 3 years. After 3 years the dividend is expected


.4%, what is the stock's value today?
urn of 10.3%. What is its value?

al gains yield, and total

d rate of return is rs =
wth rate was 5%?

d rate of return is rs =
owth rate was 0%?

Price = D1/(r-g)
Bon Temps embarked on an aggressive expansion that requires additional capital. Management decided to
payments to increase retained earnings. Its WACC is now 10%, and the projected free cash flows for the ne
cash flow is projected to grow at a constant 6%. What is Bon Temps’s total value? If it has 10 million shares
the price per share?

TTC recently introduced a new line of products that has been wildly successful. On the basis of this
success and anticipated future success, the following free cash flows were projected:

Year FCF (in millions)


1 $5.5
2 $12.1
3 $23.8
4 $44.1
5 $69.0
6 $88.8
7 $107.5
8 $128.9
9 $147.1
10 $161.3

After the 10th year, TTC's financial planners anticipate that its free cash flow will grow at a constant rate
of 6%. Also, the firm concluded that the new product caused the WACC to fall to 9%. The market value
of TTC's debt is $1,200 million, it uses no preferred stock, and there are 20 million shares of common
stock outstanding. Use the corporate valuation model approach to value the stock.

INPUT DATA: (Dollars in Millions)

Burklin, Inc., has earnings of $21 million and is projected to grow at a constant rate of 5 percent forever because of
are paid out as dividends. The company plans to launch a new project two years from now that would be complet
year. The project would start generating revenues one year after the launch of the project and the earnings from
million. The company has 7.5 million shares of stock outstanding. Estimate the value of th
Burklin, Inc., has earnings of $21 million and is projected to grow at a constant rate of 5 percent forever because of
are paid out as dividends. The company plans to launch a new project two years from now that would be complet
year. The project would start generating revenues one year after the launch of the project and the earnings from
million. The company has 7.5 million shares of stock outstanding. Estimate the value of th

Fincher Manufacturing has projected sales of $135 million next year. Costs are expected to be $76 million and net in
following year, with the growth rate declining by 2 percent per year until the growth rate reaches 6 percent, where i
require a return of 13 percent return on the company’s sto
1. What is your estimate of the current stock price?

2. Suppose instead that you estimate the terminal value of the company using a PE multiple. The industry PE mul
al. Management decided to finance the expansion by borrowing $40 million and by halting dividend
d free cash flows for the next 3 years are -$5 million, $10 million, and $20 million. After Year 3, free
e? If it has 10 million shares of stock and $40 million of debt and preferred stock combined, what is
he price per share?
at a constant rate
The market value
es of common

5 percent forever because of the benefits gained from the learning curve. Currently, all earnings
m now that would be completely internally funded and require 30 percent of the earnings that
roject and the earnings from the new project in any year are estimated to be constant at $6.7
nding. Estimate the value of the stock. The discount rate is 10 percent.
d to be $76 million and net investment is expected to be $15 million. Each of these values is expected to grow at 14 percent the
te reaches 6 percent, where it is expected to remain indefinitely. There are 5.5 million shares of stock outstanding and investors
nt return on the company’s stock. The corporate tax rate is 40 percent.

multiple. The industry PE multiple is 11. What is your new estimate of the company’s stock price?
row at 14 percent the
tanding and investors
Bon Temps embarked on an aggressive expansion that requires additional capital. Management decided t
the expansion by borrowing $240 million as secured loans and $255 million as unsecured loans and prefere
along with halting dividend payments to increase retained earnings. Its expected sales from this expnasion
860 million. Management expects to earn $261 million EBITDA and $25 million PAT. If it has 10 million
outstanding, perform the stock valaution of Bon Temps following relative valaution using comparable firm
appraoch . Information on its peers are as follows:

Trading Comparables
Sl. No. Company EV Mkt Cap EV/ Sales (x) EV/ EBITDA (x)
FY13A FY14A FY15P FY13A
A Company 1,169 989 1.4x 1.3x 1.1x 4.1x
B Company B 1,321 1,254 1.1x 1.2x 1.1x 4.7x
C Company C 1,456 1,342 1.5x 1.7x 1.5x 4.8x
D Company 1,289 1,432 1.0x 0.9x 0.8x 4.1x
E Company E 987 1,100 2.0x 1.6x 1.5x 3.8x
Mean 1.2x 4.3x
Median 1.1x 4.1x

Relative Valuation on the Basis of EV/Sales Multiple

Relative Valuation on the Basis of EV/EBITDA Multiple

Relative Valuation on the Basis of P/E Multiple


2

Core Industries is considering acquiring Duo Systems through a hostile takeover. Their plan is to mak
shareholders of Duo Systems. Eva Fox, a financial analyst with Core, has been asked to estimate a fair acq
considered using three different valuation methods to estimate the acquisition price and has gathered th
purpose.

Duo Systems Statistics


Earnings per share (EPS) ($) 2
Book value per share ($) 10
Sales per share ($) 30

Duo Systems has 1 million shares outstanding. From sixth year onwards, Fox expects Duo’s free cash flows to grow
also determines that Duo’s weighted average cost of capital of 9.5% is the appropriate discount rate

Fox did some research and found three companies from the same industry as Duo, and with a similar capital structu
Wire Dynamics. In addition, Fox could gather data for three takeover transactions with characteristics similar to Duo
and Wrap Corp. Data gathered by Fox are shown in the following figure.

Comparable Company Analysis

Mouse
Corporati Wire
- on Pad Inc. Dynamics
Comparable Company Statistics
P/E Ratio 20 18 30
P/B Ratio 3 3 3
P/S Ratio 1 1 1

Estimate the intrinsic price that Core Industries should pay for the Duo System using comparable com

Estimted Duo Systems Stock Value


Based on P/E Ratio
Based on P/B Ratio
Based on P/S Ratio
Mean Estimated Stock Value
apital. Management decided to finance
s unsecured loans and preference shares
cted sales from this expnasion plan is $
million PAT. If it has 10 million shares
laution using comparable firm mulitple
llows:

EV/ EBITDA (x) P/ E (x)


FY14A FY15P FY13E FY14A FY15P
3.7x 3.4x 15.1x 11.7x 9.3x
4.3x 3.6x 17.8x 12.2x 8.7x
4.4x 3.8x 16.1x 12.6x 9.7x
3.9x 3.5x 15.6x 12.3x 9.0x
3.5x 3.1x 13.6x 11.3x 8.7x
3.9x 3.4x 15.6x 12.0x 9.1x
3.9x 3.5x 15.6x 12.2x 9.0x

Input Data Bon Temps


takeover. Their plan is to make a tender offer directly to the
en asked to estimate a fair acquisition price for the offer. Fox has
tion price and has gathered the required financial data for this

ts Duo’s free cash flows to grow at a constant rate of 7% per year. She
is the appropriate discount rate to use for the analysis.

and with a similar capital structure—Mouse Corporation, Pad Inc., and


ith characteristics similar to Duo—Page Corporation, Cover Industries,
shown in the following figure.

Mean
Ratio
o System using comparable company analysis.
P 10800
FV 10000
CR 10%
CP 1000
n 10

YTM/rate 9%

n 10
cr 0
fv 20000
cp 0

($9,263.87)