Finance
with Dr. John Elder
LE#4
Be sure to work through the
detailed examples from class, before trying to do this on your
own! That is, before starting this problems you should be
familiar with the dividend discount model with sustainable growth and
the two stage dividend discount model.
Chapt 13# 1, 3, 4bc, 10ab, 12 , 16 (use required
return of 16%, and ignore references to "beta"), 23, 24.
1. PV = 2.10/0.11 = 19.09
3a. Use the constant growth model to get 50 =
2/(0.16-g) so g=12%
3b. PV = 2/(0.16-0.05) = $18.18
4b. True, higher ROE with tend to increase g
4c. Not always true. If ....
12.
For part (b), there are two ways to find the dividend payment.
One way is to grow earnings according to the problem, than take
out dividends using the payout/plowback ratios given (note that between
year 1 and year 2, the problem says that EPS grows 10%, and the payout
grows from 0.5 to 0.6):
| Time |
0 |
1 |
2 |
3 |
| EPS |
$1.00 |
$1.00*1.1 = $1.10 |
$1.10*1.1 = $1.21 |
$1.21*1.06 = $1.2826 |
| Div |
|
$1.10*0.5 = $0.55 |
$1.21*0.6 = $0.726 |
$1.2826*0.6 = $0.7696 |
Note also that in year 3, the terminal growth is g = ROE*b or 15%*0.4 = 6%.
(Note for advanced users: The grwoth rate in dividends from year
1 to year 2 is actually 32% -- this is due to the 10% EPS growth and
the payout increasing 20% from 0.5 to 0.6. So, 1.10*1.20 - 1 = 32%.)
Now, after you have the dividend payments, you must discount!
16. Using a required return of 16% and the growth rates
provided, you should be able to verify that the intrinsic value by the
DDM is 28.92.
23. Verify PV = 43.98.
24. FCFE equals $0.286 per share (we will work through this
partin class). Using this, you should be able to verify PV= 40.78,
Stock Trading (OTIS):
Complete a valuation of Kraft Foods Inc (KFT), using a
spreadsheet. There is template here (you will have to create
your own formulas in each cell). This includes applying some
version of the dividend discount model as well as a ratio
analysis. For the dividend discount model, you will need to
estimate the growth rate (by either using sustainable growth or some
other method) and the discount rate (We will talk more in the future
about estimated discount rates, but you may experiment with values for
now, or use a number based on (1) a benchmark of 8% scaled up or down
based on your own perception of the company's "risk" (2) the YTM on the
companies debt plus a risk premium or (3) the
CAPM.) Be sure to work through the spreadsheet
example from class first, before trying to do this on your
own! You should be able to reproduce all the calculations on
the example from class!
Note on Excel: if you load the Analysis Toolback in Excel, you will
have access to financial functions that may prove useful at some point
(select "Tools", "Add-ins" then select "Analysis Toolpack".
OTIS Journal Entry:
(1) Copy and paste your spreadsheet valuation in your OTIS journal
document. To paste (in MS Word 07), go to the drop down menu under Paste, select Paste Special, then "Microsoft Office Excel Worksheet Object".
(2) Respond to the following questions in one
paragraph: Explain whether your analysis indicates
if the stock is priced fairly. How is the company
valued relative to its competitors?
(3) Based on your analysis, is your recommendation to
"buy", "hold" or "sell"?
Useful Web URLs are