Question

. Gentry Can Company’s (GCC) latest annual dividend of $1.25 a share was paid yesterday as the company maintained its historic 7% annual rate of dividend growth. The current market price is based on the belief that the 7% growth rate will be maintained forever. However, you believe that the dividend growth rate will increase by 8% for the next three years and that in three year’s time the stock price will be $40. You and other investors require a 12% rate of return.

a) What do you believe is the current intrinsic value of GCC stock?

b) Assuming that you were right about the dividends growing at 8% forever and that the market incorporates that at t=3 in the share price. What will the price be at t=3?

c) The company Econ305 Inc, just announced yesterday that its 4th-quarter earnings were 50% higher than last year's 4th quarter. But the Econ305 share price dropped by 2.2% yesterday! Give at least two reasons why this may have happened, even though the market was, and still is, informationally efficient.

Answer 1

(A) Value of Stock with perpetual Groth of 7 % is:

P= D1/(r-g)

where:

P=Current stock price

g=Constant growth rate expected fordividends, in perpetuity

r=Constant cost of equity capital for thecompany (or rate of return)

D1​=Value of next year’s dividends​

Intrinsic Value of GCC stock = 1.25(1+.07)/(.12-.07)

= 1.3375/.05

Intrinsic Value = $26.75

(B)

Actually there is some confusion in the question. In the questino first it was mentioned that dividend will grow @ 8% for THE NEXT THREE YEARS. But in point (b) it was mentioned as GROWTH FOREVER. Here i am providing both the answers.

i) If the growth rate of 8% is forverer:

CALCULATION OF PRICE AT T=3 :

Dividend for the year T=4 is 1.25(1+.08)^4 = $1.701

Price at T=3 is : D4/(r-g)

: $1.701/(0.12-0.08)

Price at T=3 is : $42.515

ii) if the growth rate of 8% is for three years:

Dividend for the year T=3 is : 1.25(1+.08)^3 = $1.5746

Dividend for the year T=4 is : 1.5746(1.07) = $1.6849

Price at T=3 is : D4/(r-g)

: $1.6849/(0.12-0.07)

Price at T=3 is : $33.697

c)

Negative Research Notes : Sometimes a sell-side analyst will put out a (negative) research note on the company either just before or just after earnings are released.

Not Meeting the Whisper Number : Oftentimes, a company will beat the average Wall Street estimate, but fail to meet or beat the whisper number. As a result, its stock price falls. The whisper number is simply an unofficial estimate, or rumor, that is circulating around Wall Street.