1. The earnings of Best Foreca
1. The earnings of Best Forecasting Company are expected to growat an annual rate of 14% over the next 5 years and then slow to aconstant rate of 10% per year. Best currently pays a dividend of$0.36 per share. What is the value of Best stock to an investor whorequires a 16% rate of return? If stock has a market price of $15do you buy? Please include the excel formulas.
Answer:
| Current Dividend per shareD0=$0.36 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | ||
| Future Dividend Values with 14% growthuto Yr 5 | $ 0.410 | $ 0.468 | $ 0.533 | $ 0.608 | $ 0.693 | |||
| Yr 6 Dividend with 10%growth | $ 0.762 | |||||||
| Termial Value of Dividends at Yr6=0.762(1+10%)/(16%-10%) | $ 13.97 | |||||||
| Using Terminal Value formula=D0(1+g)/(k-g) , where D0 =yr 6 dividend, g=growth rate 10%, k=costof equity 16% | ||||||||
| a | Total Dividends and Terminal Valuesreceivable | $ 0.410 | $ 0.468 | $ 0.533 | $ 0.608 | $ 0.693 | $ 14.732 | |
| b | PV factor at 16% requiredrate=1/1.16^n | 0.862 | 0.743 | 0.641 | 0.552 | 0.476 | 0.41 | |
| c | PV of all future dividends andterminal value =a*b= | $ 0.354 | $ 0.348 | $ 0.342 | $ 0.336 | $ 0.330 | $ 6.040 | |
| d | Current Stcok value =Sum of ( c ) allPV of dividends & TV receivable | $ 7.75 |
| So the intrinsic value per share is $7.75 | |
| Market Price is $15 per share | |
| As the Market Price is overvalued, I shall not buy theshare. |
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