Question

11) You are analyzing the stock of Ansell Limited (Australian Stock Exchange: ANN), a healthcare company, as of late June 2008. The stock price is A $ 9.74. The company’s dividend per share for the fiscal year ending 30 June 2008 was A $ 0.27. You expect the dividend to increase by 10 percent for the next three years and then increase by 8 percent per year forever. You estimate the required return on equity of Ansell Limited to be 12 percent. A. Estimate the value of ANN using a two-stage dividend discount model. B. Judge whether ANN is undervalued, fairly valued, or overvalued.

Answer 1

A. We have following information

P0 = the current share price = $ 9.74

D0 = dividend for last year = $ 0.27 per share

k = required rate of return or cost of equity = 12%

g = growth rate of dividends = 10% for 3 years and 8% after that

With the given dividend growth rate, we can calculate the actual dividends for year 1 to 3.

D1 = $0.27 * (1+10%) = $0.297

D2 = $0.297 * (1+10%) = $0.3267

D3 = $0.3267 * (1+10%) = $0.35937

The dividends occurring in the stable growth period of 8%, we then apply the stable-growth Gordon Growth Model formula to these dividends to determine their value in the terminal year

Value in the terminal year = D3 * (1+g) / (k –g) = $0.35937*(1+8%) / (0.12-0.08) = $9.703

Now we can calculate the present value of each dividend for period 1 to 3; where required rate of return is 12%.

PV1 = $0.297/ (1.12) = $0.2652

PV2 = $0.3267/ (1.12) ^2 = $0.2604

PV2 = $0.35937/ (1.12) ^3 = $0.2558

The present value of the value in the terminal year:

$9.703/ (1.12) ^3 = $6.9064

Now add the present values of future dividends and terminal value to get current stock price

$0.2652 + $0.2604 + $0.2558 + $6.9064 = $7.6878 or $7.69

The estimated value of ANN using a two-stage dividend discount model is $7.69

B. The current share price of ANN is $ 9.74 while the estimated value of ANN using a two-stage dividend discount model is $7.69 therefore we can say that ANN is overvalued as it is selling on more than its estimated value.