Question

Assume there are three companies that in the past year paid exactly the same annual dividend of $2.27 a share. In​addition, the future annual rate of growth in dividends for each of the three companies has been estimated as​ follows:

Buggies- Are-Us	Steady Freddie, Inc	Gang Buster Group
g = 0	g = 8%	Year 1	$2.55
(i.e. dividends are expected to remain at $2.27/share	(for the foreseeable future)	2	$2.87
		3	$3.23
		4	$3.63
		Year 5 and beyond: g = 8%

Assume also that as the result of a strange set of​ circumstances, these three companies all have the same required rate of return (r=12%​).

a. Use the appropriate DVM to value each of these companies.

b. Comment briefly on the comparative values of these three companies. What is the major cause of the differences among these three​ valuations?

Answer 1

ans 1
		Buggies Are - US
		Value of the share = Dividend/required rate =		=2.27/12%
				18.92
		Steady Freddie Inc
		Value of the share = Expected dividend next year/(reqiured rate - growth rate)
				=2.27*108%/(12%-8%)
				61.29
		Gang Buster Group
		Value of share = present value of future dividend and terminal value
	year	Dividend	Terminal value	Total cash flow	PVIF @ 12%	present value
	1	2.55		2.55	0.8929	2.28
	2	2.87		2.87	0.7972	2.29
	3	3.23		3.23	0.7118	2.30
	4	3.63	98.01	101.64	0.6355	64.59
						71.46
	therefore price =			71.46
	Note - computation of terminal value
	terminal value =		=3.63*108%/(12%-8%)
			98.01
ans 2	Gang Buster group is better compared to steady freddie and buggies are -us company.
	reason for different in valuation is because Gang buster is growing at higher rate compared to other two company
	Buggies valuation is lowest compared to other two
	Therefore Gang Buster is best choice