Question

In: Finance

Smirnoff & Co is facing a rapid growth in earnings and dividends. Management projects that dividends...

Smirnoff & Co is facing a rapid growth in earnings and dividends. Management projects that dividends will grow at a rate of 12% during year 1, 10% during year 2, and 8% during year 3.

After that growth slows down to a normal rate of 5%. Company's required return is 9%. Last dividend paid (Do) was $3.50 per share.

Find: a. Horizon stock price;

b. Intrinsic stock value today.

c. Is the stock overpriced or underpriced if the market price today is $20 per share? Will an analyst issue a Buy or a Sell signal to the clients?

Solutions

Expert Solution

Required rate= 9.00%
Year Previous year dividend Dividend growth rate Dividend current year a. Horizon value Total Value Discount factor Discounted value
1 3.5 12.00% 3.92 3.92 1.09 3.5963
2 3.92 10.00% 4.312 4.312 1.1881 3.62932
3 4.312 8.00% 4.65696 a. 122.245 126.90196 1.295029 97.9916
Long term growth rate (given)= 5.00% b. Value of Stock = Sum of discounted value = 105.22
Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 3 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor

CMP at 20 is underpriced, analyst should issue a buy


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