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BUFFALO Ltd. had earnings per share of $5 as at December 31, 2015, but paid no...

BUFFALO Ltd. had earnings per share of $5 as at December 31, 2015, but paid no dividends. Earnings were expected to grow at 15.2 percent per year for the following five years. BUFFALO Ltd. will start paying dividends for the first time on December 31, 2020, distributing 50 percent of its earnings to shareholders. Earnings growth will be 6 percent per year for the next six years (that is, from January 1, 2021 through to December 31, 2026). Starting on December 31, 2026, BUFFALO Ltd. will begin to pay out 80 percent of its earnings in dividends and earnings growth will stabilize at 2 percent per year in perpetuity. The required rate of return on BUFFALO stock is 10 percent. What should be the current share price of BUFFALO?

Expert Solution

Step1: Computation of Vaue for the 1st 12 years

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

Total

a

Earnings per share

5.00

5.76

6.64

7.64

8.81

10.14

10.75

11.40

12.08

12.81

13.58

14.39

b

Dividend ($)

5.07

5.38

5.70

6.04

6.40

6.79

7.20

workings for b

50% of a

c

Present value @ 10%

3.15

3.04

2.93

2.82

2.71

2.62

2.52

19.78

workings for c

5.07/(1.1^5)

5.38/(1.1^6)

5.70/(1.1^7)

6.04/(1.1^8)

6.40/(1.1^9)

6.79/(1.1^10)

7.20/(1.1^11)

Step2: Computation of Horizon value

Earnings at the end of 11th year i.e.in 2027 will be

14.68

(14.39*1.02)

Dividend at the end of 11th year i.e. 2027=

14.68*80%

11.74

As per Gordon Model

Horizon Value of stock at the end of 11th year=

Dividend for 12th year

P11=

D12/(Ke-g)

Ke-g

=

11.74/(0.10-0.02)

=

146.75

Present value of stock=

146.75/(1.10)^11

=

$51.43

Fair value of stock = step1 + step2

=

19.78+51.43

$ 71.21

jeff jeffy answered 1 year ago

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