In: Finance
Wilbur and Orville are brothers. They're both serious investors, but they have different approaches to valuing stocks. Wilbur, the older brother, likes to use the dividend valuation model. Orville prefers the free cash flow to equity valuation model. As it turns out, right now, both of them are looking at the same stock Wright First Aerodynmaics, Inc. (WFA). The company has been listed on the NYSE for over 50 years and is widely regarded as a mature, rock-solid, dividend-paying stock. The brothers have gathered the following information about WFA's stock:
Current dividend (Upper D 0)=$1.90/share
Current free cash flow (FCF 0)=$1.5 million
Expected growth rate of dividends and cash flows (g)=8%
Required rate of return (r)=12%
Shares outstanding = 400,000 shares
How would Wilbur and Orville each value this stock?
The stock price from Wilbur's valuation is?
The stock price from Orville's valuation is?
Wilbur computation of valuation method is dividend valuation method which shall be computed as shown below:
Price = [ Current Dividend ( 1 + growth rate ) / (Required rate of return - growth rate) ]
Current dividend = $ 1.90
growth rate = 8% or 0.08
Required rate of return = 12% or 0.12
By plugging these figures in the above mentioned formula, we shall get:
= [ $ 1.90 ( 1 + 0.08 ) / ( 0.12 - 0.08) ]
= $ 51.30 per share
So, the stock price from Wilbur's valuation is $ 51.30 per share.
Stock price from Orville's valuation is computed as follows:
= [ Current free cash flow ( 1 + growth rate ) / ( Required rate of return - growth rate ) ]
Current free cash flow = $ 1.50 million
growth rate = 8% or 0.08
Required rate of return = 12% or 0.12
By plugging these figures in the above mentioned formula, we shall get:
= [ $ 1.50 million ( 1+ 0.08) / (0.12 - 0.08) ]
= $ 40.50 millions.
Now this is the value of entire firm, in order to compute the stock price we need to divide this value by the number of shares outstanding i.e.
= $ 40.50 millions / 400,000 shares
= $ 101.25 per share
Feel free to ask in case of any queries relating to this question.