Question

You’ve collected the following information from your favorite financial website. 52-Week Price Stock (Cur div) Div Yld % PE Ratio Close Price Net Chg Hi Lo 77.40 10.43 Palm Coal .36 2.6 6 13.90 –.24 55.81 33.42 Lake Lead Grp 1.54 3.8 10 40.43 –.01 131.10 70.35 SIR 2.85 3.2 10 89.14 3.07 50.24 13.95 DR Dime .80 5.2 6 15.43 –.26 35.00 20.74 Candy Galore .32 1.5 28 ?? .18 According to your research, the growth rate in dividends for SIR for the next five years is expected to be 20 percent. Suppose SIR meets this growth rate in dividends for the next five years and then the dividend growth rate falls to 5.25 percent indefinitely. Assume investors require a return of 13 percent on SIR stock. According to the dividend growth model, what should the stock price be today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current stock price $ Based on these assumptions, is the stock currently overvalued, undervalued, or correctly valued?

Answer 1

Requirement (1) – Current Share Price

Step-1, Dividend per share for the next 5 years

D0 = $2.85

D1 = $3.42 per share [$2.85 x 120%]

D2 = $4.10 per share [$3.42 x 120%]

D3 = $4.92 per share [$4.10 x 120%]

D4 = $5.91 per share [$4.92 x 120%]

D5 = $7.09 per share [$5.91 x 120%]

Step-2, Calculation of Stock Price for the Year 5 (P5)

Stock Price for the Year 5 = D5(1 + g) / (Ke – g)

= $7.09(1 + 0.0525) / (0.13 – 0.0525)

= $7.46 / 0.0775

= $96.31 per share

Step-3, The Current Stock Price

The Current Stock Price is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 5

The Current Stock Price = D1/(1 + r)¹ + D2/(1 + r)² + D3/(1 + r)³ + D4/(1 + r)⁴ + D5/(1 + r)⁵ + P5/(1 + r)⁵

= $3.42/(1 + 0.13)¹ + $4.10/(1 + 0.13)² + $4.92/(1 + 0.13)³+ $5.91/(1 + 0.13)⁴+ $7.09/(1 + 0.13)⁵ + $96.31/(1 + 0.13)⁵

= [$3.42 / 1.13] + [$4.10 / 1.27690] + [$4.92 / 1.44290] + [$5.91 / 1.63047] + [$7.09 / 1.84244] + [$96.31 / 1.84244]

= $3.03 + $3.21 + $3.41 + $3.62 + $3.85 + $52.27

= $69.40 per share

“Hence, the current stock price would be $69.40”

Requirement (2)

Based on these assumptions, the stock is currently overvalued.