Question

Big Box Chain Inc., (BBC) together with its subsidiaries, operates a chain of retail stores. The company sells a range of domestics’ merchandise, including bed linens and related items, bath items, and kitchen textiles; and home furnishings, such as kitchen and tabletop items, fine tabletop, basic housewares, general home furnishings, consumables, and various juvenile products. BBC just paid a year-end dividend of $2.00. Investors expect the dividends to grow at 20% for the next three years and after which the dividend is expected to grow at a rate of 7% forever. BBC’s stockholders require a rate of rate of return of 15%. BBC’s stock is currently trading at $42.  

Required:

Calculate the price (intrinsic value) of Big Box Chain’s stock and discuss whether this stock is over or undervalued.

Answer 1

We can calculate the current stock price using the following steps :-

1) explicit forcast period (year 1-3)

2) horizon period (beyond 3year)

3) conclusion

1) explicit forcast period (year 1-3)

divident in last year = $2

growth= 20%

re(required return) =  15%

Now we can calculate the present value of cash flow for the 3 years using the following formula :-

= {divident(y1) / 1+re1} + {divident(y2) / 1+re2}+..........................+{divident(y3) / 1+re³}

This is calculated using the help of excell as follows:-

calculations exapmle

*divident = 2*1.2 = 2.400

* pv factor = 1/1.15 = 0.870   

PRESENT VALUE FOR 6 YEARS = 6.537

2)horizon period

growth= 7%

re(required return) =  15%

present value at the end of 3rd year = divident for 4th year/ RE-G

= (3.456 * 1.07) / (0.15 - 0.07)

= 3.6979 / 0.08

= 46.224

present value at the end of 3rd year = 46.224

present value year 0 = 46.224/ (1.15)³

= 30.393

total present value = 6.537+ 30.393= 36.93

intrinsic price is $36.93, so the stock is over priced which is $42