Question

Nextbig Corp. currently has sales of $870 million; sales are expected to grow by​ 26% next year​ (year 1). For the year after next​ (year 2), the growth rate in sales is expected to equal​ 13%. Over each of the next 2​ years, the company is expected to have a net profit margin of 11​% and a payout ratio of 55​%, and to maintain the common stock outstanding at 25.85 million shares. The stock always trades at a​ P/E of 16.43 times​ earnings, and the investor has a required rate of return of 18​%. Given this​ information:

a. Find the​ stock's intrinsic value​ (its justified​ price).

b. Use the IRR approach to determine the​ stock's expected​ return, given that it is currently trading at ​$51.00 per share.

c. Find the holding period returns for this stock for year 1 and for year 2.

Answer 1

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. Figures in parenthesis, if any, mean negative values. All financials are in $ million; nos. of shares are in million and per share data like EPS, DPS, price are in $.

Parameter	Linkage	0	1	2
Sales	A	870.00	1,096.20	1,238.71
y-o-y growth			26%	13%
Net profit margin	B		11%	11%
Net profit	C = A x B		120.58	136.26
Payout ratio	D		55%	55%
Dividends	E = C x D		66.32	74.94
Number of shares outstanding	F	25.85	25.85	25.85
EPS	G = C / F		4.66	5.27
P/E Multiple	H		16.43	16.43
Price per share	I = G x H		76.64	86.60
Dividend per share	J = E / F		2.57	2.90

a. Find the​ stock's intrinsic value​ (its justified​ price).

Intrisic value = PV of all dividends + PV of terminal value = D1/(1 + r) + D2 / (1 + r) + P2 / (1 + r)2 = 2.57 / (1 + 18%) + 2.90 / (1 + 18%)2 + 86.60 / (1 + 18%)2 = $ 66.45 / share

b. Use the IRR approach to determine the​ stock's expected​ return, given that it is currently trading at ​$51.00 per share.

Please see the table below. IRR = 35.01%

c. Find the holding period returns for this stock for year 1 and for year 2.

HPR1 = (P1 + D1) / P0 - 1 = (76.64 + 2.57) / 51 - 1 = 55.31%

HPR2 = (P2 + D2) / P1 - 1 = (86.60 + 2.90) / 76.64 - 1 = 16.78%