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ceruleangoose680Lv1

28 Sep 2019

IBM has generated annual dividend growth of 15.1% over the past3 years. IBM's most recent annual dividend is $2.90. Assume IBMwill continue to increase dividends at 15.1% for the next 5 yearsbefore reducing its dividend growth to 6% for the long term. Alsoassume that the required return for IBM stock is 9.5%. It iscurrently trading for $179.90.

Use the two-stage dividend discount model to determine thecurrent intrinsic value for IBM given these assumptions.

Is the stock overvalued or undervalued? Briefly explain thepossible reasons for your response.

What long term dividend growth rate will provide an intrinsicvalue similar to the current market price?

(Leave all other assumptions in place.)

Reset the long term dividend growth rate to 6%.

What required rate of return would provide an intrinsic valuesimilar to the current market price?

(Leave all other assumptions in place.)

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Elin HesselLv2

28 Sep 2019

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1A. A stock is currently trading on the market at $25 per share. It recently paid its annual dividend of $2, has a dividend growth rate of 5% and required rate of return of 11%. Value this stock and is it over or under valued:

a. 14.50 overvalued

b. 19.52 overvalued

c. 27.50 undervalued

d. 35.00 undervalued

1B. Biagio Fortuna deposits $3,000 a month, every month, for the next twenty years, in a utility fund. The fund is expected to pay 8.35% for the life of the fund. What will the balance in Biagio's account be when he plans to withdraw in twenty years. (compounded monthly)

a. 1,630,912.00

b. 1,845,930.87

c. 2,067,325.55

d. 2,569,329.49

1C. If the inflation rate over the next twenty years is expected to average around 3%, what is the funds estimated purchasing power in today's (2017) dollars. Re-work 1B using real rate of interest. (nominal minus inflation rate)

a. 1,051,322.11

b. 1,095,321.11

c. 1,144,683.35

d. 1,284,193.72

1D. A 12% coupon rate bond makes semi-annual interest rate payments. Par value is $1,000. The bond matures in 9 years. The required rate of return is 11.07%. What is the current price?

a. $1,015.15

b. $1,052.15

c. $1,063.31

d. $1,083.35

1E. A company's stock has a beta of 1.75. The risk free rate is 4.72%, and the expected rate on stocks is 10%. If a share of this comon stock has just paid a quarterly dividend of $.35, and the long-run growth rate is 5 percent, value this stock:

a. 16.41

b. 26.58

c. 32.25

fuchsiayellowjacket605

Sabrina Gupta, an investment advisor with a major brokerage firm, was examining Wal-Mart Stores, Inc. (Wal-Mart) stock and its valuation. Gupta wondered whether to recommend the stock to any of her new clients or to existing clients who did not currently have Wal-Mart in their portfolios.

Her key task was to use an intrinsic value approach to price the shares and to then compare the resulting price with the price at which the stock was traded in the market. Gupta wanted to use alternative valuation methods and assumptions to produce intrinsic value estimates for Wal-Mart stock.

She was interested in seeing if the alternative methods would point to a consensus regarding the valuation of the stock and to see if the valuations suggested an investment opportunity given the current market price. Methods she contemplated to use were:

Multi-stage growth model

Price Earnings Multiple

Most valuation methods Gupta considered required a common set of inputs:

Future Cash Flows to Wal-Mart Investors

Growth rate of future cash flows

Discount factor or required rate of return by Wal-Mart investors

Gupta gathered data to determine each of the above.

Gupta thought that Dividends to Wal-Mart shareholders would adequately capture the cash flows to Wal-Mart shareholders; she also thought that this approach would simplify her task and she would revisit more complex valuation models if she felt the need.

Gupta thought that CAPM would provide her a relatively reliable estimate of the required rate of return. CAPM based required rate of return can be estimated by using a risk free rate, systematic risk of the firm and equity market risk premium. Gupta thought that in a valuation exercise that involve long term cash flows, 10-year government bond yield would be an appropriate risk free rate of return estimate. She checked the 10 year note rate and found out that it was about 3.68%. Gupta searched for Wal-Mart beta in Bloomberg. Bloomberg estimates betas by regressing the S&P 500 returns on the firm returns over the past two years and arrives at a ârawâ beta estimate. Bloomberg makes an adjustment in raw beta based on some academic research. Gupta is confident that Bloomberg adjustment is justified and she uses Wal-Mart beta estimate of 0.66 in her analysis.

While Gupta is aware of the importance of EMRP assumption, she thinks that Bloombergâs historical estimate of 5.05% is a safe assumption. She is aware of the fact that some studies suggest a larger risk premium of approximately six per cent, while others suggest a much lower forward-looking premium of less than four per cent. She is mindful of the arbitrariness of her assumption, and she takes a note to revisit this issue if her valuations produce unreasonable estimates.

Anticipated dividend growth (g) is often estimated in a variety of ways.

First, observed historical dividend growth can be assumed to continue in a perpetual fashion.

Second, future dividend growth can be estimated on the basis of recent estimates of analysts.

Gupta noted that the consensus annual Wal-Mart dividend for fiscal year 2011 was $1.21, and one respected analyst had estimated the expected constant dividend growth (in perpetuity) at approximately 3%.

As the chart suggests, both earnings and dividend growth rates are declining but they seem to be higher than the ârespected analystâsâ estimates. Gupta decides to use several alternative perpetual growth assumptions to see the impact on price. Since Gupta decided to use variants of dividend discount model (DDM), she checked the anticipated earnings for 2011. Analystâs estimates suggested $4.10 earnings per share. Gupta decided to use 10% growth rate from 2011 to 2012 and assumed a steady decline to 3% in 13 years (until 2024) where the perpetual growth rate of 3% resumes. She also assumed that WalMart will increase its dividend payout ratio from 30% to 55% from years 2012 to 2024. You are asked to reproduce Guptaâs analysis of multi-stage growth model and double check her valuation by using an earnings multiple. You have all the data you need to conduct the multi stage discounted growth model analysis, but you will need to do some research about the multiples valuation.