Question

ABC Company currently has sales of $250 million. The company's sales are expected to grow 20% next year (year 1) and 10% during year 2. The analyst expects the company to have a net profit margin of 8% each year, a dividend payout ratio of 50%, 15 million shares of common stock outstanding over the time horizon, and sell for a p/e ratio of 15 at the end of year 2. If the required rate of return is 20%, then what is the stock's intrinsic value?

Answer 1

Given about ABC Company,

Sales = $250 million

Sales are expected to grow at 20% for next two year

So, sales in year 1 = 250*1.2 = $300 million

Sales in year 2 = 300*1.2 = $360 million

Net profit margin = 8%

dividend payout ratio = 50%

so next year dividends = sales*NPM*Payout ratio = 300*0.08*0.5 = $12 million

common share outstanding = 15 million

So, next year dividend per share D1 = 12/15 = $0.8

For year 2, dividends = 360 * 0.08 * 0.5 = $14.4 million

So, year 2 dividend per share D2 = 14.4/15 = $0.96

Net income in year 2 = 360*0.08 = $28.8 million

EPS in year 2 = 28.8/15 = $1.92

stock sell for a p/e ratio of 15 at the end of year 2

So, price at year 2 end P2 = P/E * EPS = 15*1.92 = $28.8

required rate of return rs = 20%

So, current stock price is sum of PV of future dividend and P2 discounted at rs

P0 = D1/(1+rs) + D2/(1+rs)^2 + P2/(1+rs)^2 = 0.8/1.2 + 0.92/1.2^2 + 28.8/1.2^2 = $21.33

So, intrinsic value of stock today is $21.33