Question

1. HF Corporation just paid a dividend of $4.00. The dividend is expected to grow by 8% this year, 6% in year two and 5% in year three. Beginning in year four, the dividend is expected to grow at a constant rate of 4%. With a required return of 10%, what is a share of this company’s stock worth today?
2. TP Company report FCF of $800,000 in the most recently completed year. FCF is expected to grow by 10% this year and 7% in year two. Beginning in year three, FCF is expected to grow at a constant and sustainable rate of 5%. The required rate of return on this stock is 12%. The company has debt of $3,500,000, preferred stock of $1,200,000 and 500,000 common shares outstanding. What is a share of this company’s common stock worth today ?

Answer 1

1). Given about HF corporation,

Last dividend D0 = $4

D1 = 4*1.08 = $4.32

D2 = 4.32*1.06 = $4.5792

D3 = 4.5792*1.05 = $4.8082

Thereafter growth rate is constant

g = 4%

Required rate of return r = 10%

So, Price of the stock at year 3 using constant growth model is

P3 = D3*(1+g)/(r-g) = 4.8082*1.04/(0.1-0.04) = $83.3414

So, current stock price P0 = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + P3/(1+r)^3

=> P0 = 4.32/1.1 + 4.5792/1.1^2 + 4.8082/1.1^3 + 83.3414/1.1^3 = 73.94

So, current stock price is $73.94

2). Given about TP compant,

Last FCF F0 = $800000

F1 = 800000*1.1 = $880000

F2 = 880000*1.07 = $941600

Thereafter growth rate is constant

g = 5%

Required rate of return r = 12%

So, value of operation of the stock at year 2 using constant growth model is

V2 = F2*(1+g)/(r-g) = 941600*1.05/(0.12-0.05) = $14124000

So, current Enterprise Value EV = F1/(1+r) + F2/(1+r)^2 + V2/(1+r)^2

=> EV = 880000/1.12 + 941600/1.12^2 + 14124000/1.12^2 = 12795918.37

So, Market value of equity = EV + Cash - Debt - Preferred stock = 1275918.37-3500000-1200000 = $8095918.37

Price of the share = MV of equity/number of shares = 8095918.37/500000 = $16.19